S&P 500 - Ten Stocks to Avoid

Understanding the true intrinsic value of a company is very important when attempting to identify and take advantage of mispriced securities. The Applied Finance Group (AFG) has proven to be successful at helping their clients find attractive investment opportunities and also help avoid potential torpedo stocks by utilizing their Economic Margin Framework. AFG’s Economic Margin (EM) is the measure of the true economic profitability a company is earning after several adjustments to eliminate distortions caused by traditional accounting practices. Understanding a company’s EM levels and expected changes in EMs is important as it has been proven through vigorous back-tests that a company’s expected change in EMs is highly correlated with the company’s future market performance. Companies expected to improve their EM’s have proven to be more likely to outperform than those companies with declining EMs.

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Source (The Applied Finance Group)

Since the direction EMs are heading has such a correlation with market performance, we have put together a list of companies that are in the bottom half of their sector in expected EM change. These companies are not focusing on, or are unable to improve their overall profitability relative to their sector peers, and look to be more likely to underperform. Along with the lack of improvement to their overall profitability, these firms also rank very low amongst their sector peers in Valuation according to AFG’s Valuation Model, making all 10 of these firms look overvalued. These 10 firms also meet AFG’s default Sell criteria (explained below), which beyond valuation and EM change, factor in a Management Quality score, which measures management’s ability to create shareholder value. All of these firms did not fare well based on AFG’s criteria to be an attractive investment opportunity and should be avoided or at least carefully reviewed if any of these are being considered as additions to an investor’s portfolio.

AFG's Buy/Sell Criteria - factors in Economic Margin, Management Quality, and AFG's Valuation Metric. In order to determine Management Quality, AFG scores management on their growth decisions in accordance with the company’s ability to either create or destroy wealth. AFG's Valuation Metric measures a company's Percent to Target (the deviation between a stock's current trading price and its AFG current default target price). To derive the intrinsic value of a firm, AFG uses its proprietary Valuation Model.

AFG's Valuation Metric – Measures the percent to target (deviation between a stock’s current trading price and its AFG current default target price). To derive the intrinsic value of a firm, AFG uses its proprietary Valuation Model (modified discounted cash flow model).

Management Quality – Assesses management’s ability to make wealth creating decisions. See one of our previous assessments of company management here.

Comments

[doc_hawkins:]

In the equipment world buying Cat is like in the Tech mainframe world by IBM. In the very short term you may have a bit of credibility after this rally for maybe a month
But after the buying opportunity is in it will be crystal clear you and your stats have no clue as far as Cat is conserned

Aug 04 08:06 AM

[platehead:]

X has been a great stock to make money with.

Aug 04 08:08 AM

[User 130385:]

RRC has been incredible. They have held their value in an extremely volatile market. They are a low cost driller of natural gas, with Nat Gas price hedging they have had a very strong 2009. And once they develop the Marcellus Shale more will look even better. They are still in a growth phase and are doing a good job with their leverage as well as drilling expenses.

Aug 24 05:36 PM

[David Yang:]

I am wonder why to avoid to buy NSM (National Semiconductor). Can you specify the reasons ?

Nov 10 04:49 AM

[David Yang:]

I am wonder why to avoid to buy NSM (National Semiconductor stock) since she has great margin from four years ago. Please specify the reasons.

Nov 10 04:50 AM