Our Portfolio Performance Update

Every June, The Applied Finance Group (AFG) hosts its annual conference in Las Vegas to help its clients improve their understanding of AFG’s methodology and valuation framework. Putting these concepts into practice, AFG also provides several actionable Buy ideas that clients can add to their portfolio, upon returning to their office. One of the most popular sessions during the conference is called “Hot Stocks”- a time when AFG analysts give detailed analysis of several stocks that are currently of great interest to the investment community.

Since its release on June 12, 2009, the “Hot Stocks” portfolio has outperformed the Russell 1000 by 5.85%. Below is a look at the four Buy recommendations within the “Hot Stocks” portfolio, and their performances as of August 13th 2009. Also provided below is the performance of the Russell 1000 index during the same time period.

click to enlarge

Today Value Expectations will be issuing a ranking of the entire S&P 500 to registered Valueexpectations.com users. Register now to ensure that you receive this article.

Additionally Toreador's Large Cap Fund (TORLX) which uses AFG's Economic Margin Framework as part of its investment philosophy has recently crossed it's 3 year track record threshold, Click here to view TORLX performance.

A brief description of AFG's buy criteria variables:

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).

Economic Margin - A corporate performance measurement that addresses the gaps in GAAP, eliminating distortions caused by accounting policies to measure what a company is truly earning above or below their cost of capital.

Management Quality – Assesses management’s ability to make wealth creating decisions.

AFG's Value Universe - Companies in the AFG universe, which have MV/IC at the bottom 50% of the universe and have EPS estimates.

Comments

[TradingHelp...:]

Interesting that you combine 2 quantitative measures, economic margin and the metric valuation system with a qualitative measure - the effectiveness of management.

It makes sense to me and I can see how you might outperform. One thought / question; Do you guys meet management and ask questions face to face or do you assess them using publicly available information?

Aug 14 04:29 AM

[Value Expec...:]

TradingHelpDesk, Good questions.

No, we do not meet with any management teams. We use our Management quality score to measure if the company is generating positive or negative Economic Margins. We don’t like to see them grow the business if they have negative economic margins, we would like to first see them shrink and fix the business first. If they have positive economic margins, we do like to see them grow.

The only time we ever meet with management teams is for corporate consulting. We help corporations structure management compensations plans or to value acquisitions and divestitures.

I do want to clarify something on our valuation system. Based on this comment on other questions you have asked about solving for sales growth. We are using our economic margin to measure historical economic profits, simply to see how well management runs its business, but our valuation system also uses Economic Margins. Basically we are forecasting Economic Margins in the future, our DCF Model with NO perpetuity; we assume that economic margins will decay over time to zero (we do this on a company specific basis). Once Economic Margins are zero then that means that the company is earrings its cost of capital, so growth is irrelevant. What we are doing next is discounting the future economic margins to come up with an intrinsic value.

We will be writing more articles about how we calculate and use Economic Margin on our site that may not show up on Seeking Alpha. I encourage anyone that wants to read to register on our site (Value Expectations.com) to ensure they access the articles or receive via email:

www.valueexpectations....

Lastly, we are using publicly available information to build our models. But again, we are taking that data and making adjustments which leads to our development of Economic Margins.
Thanks for all your feedback and Questions, hope this clarifies things.

AFG



On Aug 14 04:29 AM TradingHelpDesk wrote:

> Interesting that you combine 2 quantitative measures, economic margin
> and the metric valuation system with a qualitative measure - the
> effectiveness of management.
>
> It makes sense to me and I can see how you might outperform. One
> thought / question; Do you guys meet management and ask questions
> face to face or do you assess them using publicly available information?

Aug 14 08:07 AM

[Value Expec...:]

TradingHelpDesk, Good questions.

No, we do not meet with any management teams. We use our Management quality score to measure if the company is generating positive or negative Economic Margins. We don’t like to see them grow the business if they have negative economic margins, we would like to first see them shrink and fix the business first. If they have positive economic margins, we do like to see them grow.

The only time we ever meet with management teams is for corporate consulting. We help corporations structure management compensations plans or to value acquisitions and divestitures.

I do want to clarify something on our valuation system. Based on this comment on other questions you have asked about solving for sales growth. We are using our economic margin to measure historical economic profits, simply to see how well management runs its business, but our valuation system also uses Economic Margins. Basically we are forecasting Economic Margins in the future, our DCF Model with NO perpetuity; we assume that economic margins will decay over time to zero (we do this on a company specific basis). Once Economic Margins are zero then that means that the company is earrings its cost of capital, so growth is irrelevant. What we are doing next is discounting the future economic margins to come up with an intrinsic value.

We will be writing more articles about how we calculate and use Economic Margin on our site that may not show up on Seeking Alpha. I encourage anyone that wants to read to register on our site (Value Expectations.com) to ensure they access the articles or receive via email:

www.valueexpectations....

Lastly, we are using publicly available information to build our models. But again, we are taking that data and making adjustments which leads to our development of Economic Margins.
Thanks for all your feedback and Questions, hope this clarifies things.

AFG

Aug 14 08:07 AM

[Steve Selengut:]

Investment Performance Expectations and Broker Account Statements

As impossible as it is to predict the future of the markets, it's relatively easy to anticipate what you are going to experience when you view your next brokerage account statement.

Whether you go the discount route through Schwab, Ameritrade, Fidelity, etc., or enjoy a higher level of service through an independent like LMK Wealth Management, you should never be surprised by the market values reflected on your monthly statement.

None of the firms make it easy for you to examine asset allocation, particularly on a working capital basis, and most refuse to even acknowledge that Municipal CEFs should not be lumped in with the equities. Additionally, no brokerage statement ever includes a warning label about the dangers of margin borrowing. Surprised? Not.

But you can be sure that all statements will emphasize (in every conceivable way) the short-term change in your market value. Any long term or cyclical analysis (if any) is reserved for the "we understand your long term objectives" propaganda that fills their prospect-only glossies.

Statement market value movements in both directions need to be anticipated and understood, not labeled bad or good (rhyming not intended). Investigation is required when you reasonably expect one direction and you wind up with another--- with the emphasis on the reasonableness of your expectations.

Someone should provide a simple analytical mechanism that will allow investors to know precisely what to expect from the monthly statement opening ritual--- and to have a fairly good idea of why the values have changed the way they have. No shocks, surprises, or indigestion.

I'll take a shot at it, but you should know that IGVSs are those few "value stocks" (in the classic definition) that are also B+ or better rated by S & P, dividend paying, generally profitable, and traded on the NYSE.

The IGVS expectation analysis process will prepare you for the dreaded monthly account statement--- whether you get there by password and click or by post office and letter opener.

Only four bits of information are really needed (for WCM users), and I'm assuming a 70% to 30% portfolio asset allocation--- equities vs. income, respectively.

One: An increasing Investment Grade Value Stock Index (IGVSI) will lead to higher market values for the stocks in your portfolio, but not if you just think that you own mostly IGVSs in your Mutual Funds.

Two: When you are looking for stocks that fit your buying parameters (not hot tips from "Heard on the Street", "Mad Money" or CNBC), a higher number of "bargains" will generally mean lower equity market values.

Three: If monthly (IGVS) Issue Breadth numbers are significantly positive, higher market values should be expected. For the uninitiated, issue breadth analysis compares the daily number of stocks going up in price with the number going down.

Four: If there are fewer IGVSs establishing new 52-week lows than new 52-week highs, it is likely that overall equity market values are rising.

So how do you think you did in August--- click, click, head-scratch?

The Investment Grade Value Stock Index was up for the fifth time in the past six months. The number of bargain stocks was below the average of the past six months. Issue breadth was positive. There were more 52-week highs than lows--- only one new 52-week low all month.

In other words, all indicators point to a higher market value in August than in July and a continuation of the upward trend that started in March.

Additionally, in spite of conditions where interest rates cannot really go much lower, rate sensitive CEFs continued to move slightly higher--- signaling further strengthening (for now) in the credit markets.

So what could keep you from having a better portfolio picture this month than last (from a short-sighted market value perspective)?

Well, Virginia, in the non-government world where most of us attempt to survive, disbursements in excess of income and deposits will do it every time. And when the market corrects, as it absolutely always will to some extent, the double whammy on the bottom line can be painful.

Tracking breadth, new highs and lows, bargain numbers, and an index that mirrors the types of securities you hold in your portfolio, can explain what is happening. Regular additions to your portfolio can soften the impact of a correction and help you prepare for the rally that inevitably follows.

Now if we could only convince the SEC to require that account statements be divided by security purpose (growth or income, for example) instead of by trading unit.

And market cycle analysis--- maybe next year.


Steve Selengut
Sanserve-at-aol.com
www.kiawahgolfinvestme...
Professional Investment Management from 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"

Sep 02 01:01 PM