Today we will focus on the Capital Goods sector and provide readers with a few names we like as well as a couple that we don’t in terms of investment attractiveness from within this sector. We will also take a look AFG’s Management Quality Chart to help us better understand each of these companies from a corporate performance and strategic standpoint. Lastly, using snapshots from here (AFG’s web-based research platform), we will take an in-depth look at Fluor Corp. (FLR).
Based on key investment criteria including valuation and management quality, we listed a few companies in the Capital Goods sector that appear to be attractive as well as a few that do not.
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At AFG, we place great importance on management’s ability to create wealth for its shareholders. To help us understand a company’s management strategy and its ability to create wealth, we use the Management Quality Chart developed by AFG to visually distinguish between wealth creators and wealth destroyer. We define wealth destroyers as companies which continue to grow their businesses even when they are not profitable (generating negative Economic Margin or negative EM, which is AFG’s way of understanding a firm’s economic profitability). When business units are unproductive, or in other words, destroying wealth, management should not be looking to grow that business unit but instead, fix the broken parts of its business first by divesting losers and improving profitability. Companies that successfully improve profitability and create wealth earn the right to grow. The best strategy AFG or any investor likes to see is a very profitable business (generating positive EMs) that grows its assets to maximize its profitability.
Looking at the Management Quality Chart below, AFG likes to see companies in the top right quadrant. Companies in this quadrant are companies that are improving its economic profitability and at the same time growing out its asset base to maximize its profitability. As you can see the 2 companies that are the most unattractive (TXT, SWK) according to other AFG criteria are also the same companies that appear to be following a wealth destroying strategy.
Management Competence Factors
• Have there been any changes in the executive management team?
• Has the company had any significant write-offs or poor earnings quality?
• Has the company recently made any significant acquisitions and, if so, what are the strategic implications and costs?
• How is the company spending any excess cash?
• What did we learn from the company’s most recent earnings call and what was the tone of analyst questions?
Management Quality Score Insights:
• Measures a company’s EM+1 and LFY Asset Growth.
• Companies that have positive EMs should grow their business while firms with negative EMs should focus on profitability and earn the right to grow.
• Un-bias quantitative way to analyze a company
• Holds management teams accountable for unprofitable growth
Next we will take a more in-depth look at Fluor Corp. a company we find attractive, through snapshots from afgview.com. In the 3 charts below you can see why we like FLR. 1) Trading at a discount 2) Following a wealth creating strategy 3) Low expectations to grow sales relative to what they have delivered in sales growth historically.
Wealth Creation Strategy
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