Everything we do at The Applied Finance Group (AFG) centers around valuation, it is the foundation of our research process. Helping our clients come to realistic and insightful valuation conclusions is the main value that we add for our clients, and the biggest reason why we are a major part of the stock-picking process of over 250 institutional firms around the globe.
Our valuation framework essentially strives to correct many of the common distortions in “as reported” financial statements in order to create a set of economic financial statements for companies that work well across time, industries, sectors, and market capitalizations. We believe that this process puts us in a superior starting position when evaluating the attractiveness of any investment as we are comparing apples to apples, and not susceptible to many of the shortfalls of traditional accounting approaches to evaluating investments.
AFG’s Valuation Model:
- Begins with a more refined measure of corporate performance (Economic Margin)
- Corrects common distortions in GAAP accounting
- Models the effects of competition using company specific Competitive Advantage Periods
- does not make perpetuity assumptions
- assigns company specific discount rates
- Inflation adjusts asset base to allow for better comparability (new vs. old firm) and across time
AFG’s discounted cash flow model provides money managers a significant advantage in stock selection. The ability to control and more accurately forecast the inherent assumptions in a multiple (perpetuity, decay, growth, and the discount rate) has proven to have a much stronger correlation to market performance than traditional accounting approaches to valuation. By discounting future levels of economic profitability, using company specific discount rates and competitive advantage periods, we are able to assign much more accurate and meaningful valuations to companies.
Our valuation approach has a proven track record of consistently identifying companies trading above or below their intrinsic valuations across sectors, market capitalization groups, and growth/value universes. Our valuation model has done an excellent job at adding alpha to picking stocks as evidenced in the chart below highlighting the performance achieved within the Russell 1000 index (1998-Present). The entire index is broken down into quintile buckets, the “A” bucket contains the most undervalued stocks in the index while the “F” bucket contains the most overvalued stocks.
The table below contains 10 companies that are currently flagged as overvalued (F Valuation Grade) within the Russell 1000 index. These firms should be evaluated carefully if you currently own or are considering adding shares of these companies to your portfolios as they currently look extremely overvalued relative to sector and index peers.
Russell 1000 – Overvalued Companies