For many, the price of the Dow is merely a number. A number that is a more accurate measure of how a trader feels about the economy, than an investor with a long-tem focus. Since January 1st, the Dow has yielded nearly 6.91%, and has a current price to earnings ratio of roughly 13.71x. Since 2009, the Dow's average return on equity has increased to 30.5% from 25.5%. But in terms of both gross and profit margins, we have yet to see a full recovery. This article provides a broad overview of the fundamental performance of the all thirty securities underlying the Dow through a scoring methodology that uses Poitroski's Fundamental Score.

The fundamental scoring model used in this article is a slight variation of Poitroski's traditional model. For those who are unfamiliar with this model, it is simply a combination of nine different accounting checks used to derive a final score reflecting the quality of a specific firm. The final score is a discrete number ranging from zero to nine that focuses on a firm's financial position through concentrating on three key areas. These three key areas include profitability; leverage, liquidity, and source of funds; and operating efficiency. The maximum points that can be achieved from each category is four, three, and two respectively. Each firm receives a point for every constraint it satisfies below.

Profitability

1. Positive net income in the current year
2. Positive operating cash flow in the current year
3. Return on assets must be increasing and greater than the previous year
4. Operating cash flow must be greater than return on assets and net income

Leverage, Liquidity, and Source of Funds

1. Lower level of long-term debt in the current year relative to the value of total assets in the previous year
2. The current ratio must be greater than the previous year
3. There must be no additional equity issued in the previous year

Operating Efficiency (maximum, 2 points)

1. Gross margin must be progressively increasing and higher than it was in the previous year
2. Asset turnover must be increasing as well and higher than it was in the previous year

The Fundamental Scoring Model

The output shown below illustrates the fundamental score of each company in the Dow as well as the firms score for every category. Notice the firms have been ranked in alphabetical order and not by they fundamental score they received. The output of this model revealed a decent variation in the results. Not a single firm received a score of nine. The top two firms, Cisco Systems (CSCO) and Home Depot (HD), both received a score of eight. Next in line was Walt Disney (DIS), AT&T (T), and The Travelers Companies (TRV), which all received a score of seven. The remaining twenty-five companies in the Dow received a score less than or equal to six. The stand-alone arithmetic average score of the overall index is 4.6, which is extremely low. If you take a close look at the figure below, you will notice the variation between a pass and fail score is easily distinguished by the green and pink highlighting, respectively.

Among the three categories, profitability appears to be the Dow's strongest fundamental attribute. With the exception of Hewlett- Packard (HP), every firm within the Dow displays positive operating cash flow. The parameters evaluating the quality of these firms earnings revealed great results, which is expected given positive signs of strong operating cash flow across the board. In regards to profitability, the primary concern is return on assets. From year over year, more than half of the firms in the index have failed to improve their return on assets.

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As indicated by the cells highlighted in pink, the key issues concerning these firms within the index are primarily concentrated around the right portion of the chart. This area includes operating efficiency, liquidity, and leverage. All of these factors have major implications on a long-term growth. A firm's sustaintable growth rate is indirectly a function of its leverage and operating efficiency. And the ability for a firm to sustain long-term growth can be heavily influenced by poor performance in these areas.

In regards to leverage, the issue lies at the heart of a firms capital structure. This model does not take into account the specific value of a firm's weighted average cost of capital, however it contrasts its long-term debt with its assets from the previous period. This provides an understanding as to how leveraged a single firm is in terms of its financing through debt. As you will see above, this model reveals that majority of these firms are using a substantial amount of debt financing. In terms of liquidity, this model suggests roughly half of the firms in the Dow are experiencing lower levels of liquidity now as opposed to the previous year. Majority of the firm's current ratios declined over the past year. Five of the firms that improved their current ratio from the previous year engaged in the issuance of new equity. Using equity issuances for sources of funds was most likely utilized for paying off portions of long-term debt as well as finishing up existing projects. The last category this model focuses on is operating efficiency. Unfortunately, this area does not reveal the most promising results. The only three firms to pass both constraints under this category are HD, T, and Walmart (WMT). All three firms not only increased gross profit margins from the previous year, but also have displayed a progressive increase in its turnover on fixed assets.

Conclusion

Considering the definition of accuracy, all models are wrong. The value added from a model is not if its 100% right or wrong, but rather how its utilized. The value added solely derives from the utility you receive from it. In practice, as long as the underlying assumptions and data used in the model are credible and precise, the model therefore has a useful purpose. The model used in this analysis takes into account these firm's most recent financial data and was constructed with the intent of providing a big picture view of the financial condition for each firm in the Dow. Overall, the firms within the Dow are exhibiting strong levels of profitability, however there is a lot of uncertainty surrounding capital structure and operating efficiency. In the short-term, I feel a small-correction as a result of traders selling off positions to retain profits is highly plausible. However, my main concerns still reside underlying long-term growth prospects because lowered levels of liquidity and declines in operating efficiency will only suppress long-term growth.

Sources: TD Ameritrade, Bloomberg, Google Finance, and The Wall Street Journal.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

To clearly illustrate this strategy, I am going to use the one year price target I computed of $20. Note this is my price target for the end of December FY 2013 and while the expiration date of the options contracts I will discuss exceed this date, it is important to recognize American call options can be traded or exercised up to any point before or on the date of expiration. Please refer to my first article for details behind this calculation. This options strategy involves using a regular call option. Looking at figure 1 below, you will see Alcoa is trading at roughly $8.85 per share. Hence, at this market value per share Alcoa is nearly $11.15 from my price target, which suggests a significant upside.

Figure 1: AA's Five Year Price Graph

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Initiating a long position in a single company provides exposure to ones capital that is not suitable for everyone due to a wide assortment of risks. There are many additional ways to benefit from the potential rise in Alcoa's price and in this scenario a call option is most appropriate. Below I have provided the most recently updated options chain for Alcoa call options expiring on January 18, 2014 and January 17, 2015, which can be easily at Google Finance. For both investment horizons, I am going to focus on the options contracts with a $10 strike price.

The closing price for one Alcoa call options contract expiring on January 18, 2014 at a strike price of $10 was $0.49, or the equivalence of $49 per contract. This provides extreme leverage for individuals striving to benefit from future rising prices in Alcoa's security market price, but do not want to suffer in the case there were to be a significant decline in its security market price. In other terms, by January 18, 2014 if Alcoa's security market price per share was below $10 and the investors still remained holding the contract, it would expire worthless and the investor would face a maximum loss of the premium he paid, which in this case was $49. As you can see, the potential leverage to be achieved can be significant, while an investors loss is capped at a maximum.

Figure 2: January 18, 2014 Call Options Chain

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This next options chain for Alcoa extends the investors horizon by an another year, which you will see is priced into the premiums in contrast to the options chain expiring one year prior. Notice the variation in the premiums for the call options with a $10 strike price in contrast to the previous year. This takes into account maturity and from one view implies market participants may have a more bullish view of Alcoa's performance in FY 2014 as opposed to its performance in FY 2013. But from a broad perspective, the major difference is there is a $52 dollar difference in the premium for contracts with an expiration date of one year longer in maturity.

Figure 3: January 17, 2015 Call Options Chain

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If Alcoa's market value per share reaches $20 on or before January 18, 2014, the total profit for investors would be $951 per contract, and respectively $897 per contract for options expiring the following year. This assumes a $49 and $103 premium paid per contract for January 17, 2014 and January 18, 2015, respectively and excludes brokerage transaction costs. Note after Alcoa's market price per share exceeds the strike price of $10 it is classified as in-the-money, and due to the nature of being an American option can be exercised on or anytime before the expiration date. Therefore, investors will begin to profit as they surpass the value required to break even, which is simply the strike price plus the premium. The break even point for the call option chains for 2014 and 2015 are $10.49 and $11.03, respectively.

In addition two these two investment strategies, there is another alternative that is more conservative in nature and suitable for those interested in initiating a long position in the security its self. This strategy involves initiating a long position in the security and simultaneously purchasing put option contracts that correspond with your desired investment horizon. These contracts will hedge the investors position to a decline in Alcoa's market price per share. Given analysts expectations surrounding the future price of aluminum, the most suitable investment horizon for this strategy is roughly two years. Looking at figure 3 below, you will see the premiums for the $17, $15, $12, and $10 are all significantly high and this is because of all these options are currently in the money. Put options are inversely related to call options and principally exactly the opposite. For instance, if one were to purchase 100 shares of Alcoa at its current market price per share of $9 with the intention of holding the underlying position for quite some time, the investor would then want to purchase one put option contract with a strike price of $10 as the price of the security slowly increases. In this case, by waiting for the security price to increase closer towards $10 per share the premium for which you can purchase the put option for will decrease because it will be closer towards being out of the money.

Figure 3: January 17, 2015 Put Options Chain

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In conclusion, Alcoa has serious potential to provide investors with a substantial upside and utilizing options is just one method for investors to benefit from Alcoa's success.

Sources: The graphs and options tables used in this analysis were retrieved from YCharts and Google Finance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Overview

ESA provides contracting services for energy related companies. Its services include installation, replacement and repairs of pipelines for the oil and natural gas industries, general electrical services for both power companies and various other industrial applications, installation of water and sewer lines for various governmental agencies, and various other ancillary services. In addition, ESOA also provides services for liquid pipeline construction, pump station construction, production facility construction, and other services related to pipeline construction. ESOA currently has 602 employees serving customers that are primarily located in the Mid-Atlantic region in states such as West Virginia, Virginia, Ohio, Pennsylvania, Kentucky, and North Carolina. Note these are the most common areas in which ESOA operates and that it does operate nationwide. Here is a specific list outlining a few of ESOA's customers:

• Spectra Energy
• Dominion Resources
• Columbia Gas Transmission
• Columbia Gas of Ohio and Pennsylvania
• Nisource
• Marathon Ashland Petroleum LLC
• American Electric Power
• Toyota
• Hitachi
• Kentucky American Water
• Equitable Resources
• Markwest Energy
• Range Resource

It is important to note that due to the seasonal impacts on ESOA's operations activities such as laying pipeline often does not occur during winter months, therefore not all of the customers listed above can be classified as year-around customers. In order to provide services to its customers, ESOA operates through its wholly owned subsidiaries including:

1. S.T. Pipeline, Inc.
2. C.J. Hughes Construction Company, Inc.
3. Nitro Electric Company

For additional information pertaining to ESOA and its subsidiaries please visit ESOA's company website or click on the link above corresponding to the individuals subsidiary of interest.

Relative Performance & Competitive Environment

As you will see below in figure 1, following the credit crisis in 2008/2009 ESOA's market value per share fell dramatically and has remain relatively stagnant since. ESOA is currently trading at the bottom of its valuation and in terms of a value play by definition it would be a buy, however substantial debt outstanding and low levels of profitability merely make this stock one to watch in the short-term.

Figure 1: ESOA's Relative to S&P 500

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To illustrate the performance of ESOA's peers relative to the S&P 500 over the past five years, I used YChart's custom graphs. The companies used in this peer analysis include Matrix Service Company (MTRX), Cal Dive International (DVR), MasTec(MTZ), Primori Services Corporation (PRIM), and CDI Corporation (CDI).

Figure 2: ESOA's Peers Relative Performance

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As I have illustrated, you will clearly see that ESOA operates in an industry that is highly competitive in nature. The companies I have outlined in figure 2 above are only a few of ESOA's peers. The high level of competition derives from optimal financing strategies that require high maintenance costs and abnormally high levels of capital adequacy to fund operations. In addition contracts for pipeline are typically awarded through a competitive bid process.

Backlogged Work Still Exists, But Improvements Are Underway

By analyzing ESOA's 10-K for the end of FY 2012, it is clear the substantial amount of backlogged work can be attributed to the negative decline in ESOA's profitability and significant downfall in market value over the course of the past year. According to ESOA's 10-K, as of September of FY 2012 there was approximately $57.4 million dollars in work to be completed on existing contracts outstanding, which is comparably less than the $128.5 million in backlogged work for the previous year at this date. Note ESOA's backlogged work represents contracts for services that have been entered, but have yet to be commenced. One reason for this is mentioned by ESOA's management:

"Due to the timing of ESOA's construction contracts and the long-term nature of some of our projects, portions of our backlog may not be completed in the current fiscal year."

The primary reason for this has to do with the ESOA's average duration in terms of how long it takes to complete a project from time the contract is initiated to the time it is ended. The majority of ESOA's projects can be completed in a relatively short period of time with a project lifespan ranging from two to five months. Larger scales projects can take upwards to 18 months to be completed. One of the key issues ESOA's encountered over the past year was unforeseen weather condition, which ultimately served as a barrier delaying the completion of existing and start of new contracts.

Capital Structure

Another area of concern that has significant implications on ESOA's ability to complete projects is its capital adequacy, basically the working capital available to fund projects. Its primary source of debt derives from its $18 million line of credit with a regional bank and under a Forbearance Agreement ESOA has agreed to a 6.5% interest rate on the principal outstanding during this period. The Forbearance Agreement between ESOA and its lenders was established and made effective on November 28, 2012. The primary disadvantage of this agreement is it prevents ESOA from making additional draws on its revolving line of credit. In addition, as stated in ESOA's 10-K the major covenants governing this line of credit are:

1. Its current ratio cannot fall below 1.5.
2. Debt to tangible net worth must not exceed 3.5.
3. Capital expenditures must not exceed $7.5 million per year.
4. Dividends shall not exceed 50% of taxable income without prior bank approval.

This Forbearance Agreement may be terminated upon certain evens and in any case on May 31, 2013. The termination of a contract as such would have a dramatic effect of ESOA's ability to complete projects. Primarily, it would restrict its working capital available to allot to unfinished projects. ESOA has the potential to receive a separate forbearance line of credit, if it were to apply and be accepted, however taking into account ESOA's current level of profitability and capital structure this not highly plausible.

An additional concern I have underlying the Forbearance Agreement is in regards to its subsidiary S.T. Pipeline and is clearly written in its 10-K:

"The Forbearance Agreement, among other things, requires that we close our S T Pipeline subsidiary and dispose of its assets."

For an easy reference, here is ESOA's long-term debt outstanding listed in order of maturity.

Figure 3: ESOA's LT-Debt Maturities

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Off-Balance Sheet Risk

In terms of off-balance sheet items investors need to be aware of ESOA's practice of lease financing and its concentration of credit risk that derives from customer transactions. In practice, it common for firms to exclude short-term financing for items such as leases from the balance sheet, however ESOA excludes several long-term items as well.

ESOA has various leases that are not capitalized and therefore are not reported on its balance sheet. These leases are specifically to help ESOA obtain equipment, vehicles, and facilities that are depreciable in nature and serve little benefit if purchased for long-term use. ESOA first lease obligation consists of two pieces of real-estate under-long term agreements extending through August 15, 2014, which require monthly rental payments of $5,000. ESOA's second lease agreement is for its headquarters office and requires monthly payments of $7,500 with an option to renew expiring October 2013. ESOA's last lease agreement is for its office and shop space requiring monthly payments amount to $11,800.

ESOA's level of internal credit risk revolves around and in entirely dependent upon the credit extended to customers. These lines of credit are extended to customers under normal payment terms, however it is typically unsecured credit meaning its extended without any form of collateral to back it up.

Valuation

ESOA is highly leveraged in terms of its debt financing and unfortunately is highly associated with the significant decline in its security market price as has been clearly priced in. ESOA's current market capitalization is roughly $7.95 million, which is slightly more than the book value of its stockholders' equity on its balance sheet for the period ended September 30, 2012. Highlighted below in figure 4, you will see total assets were $59,755,749 and total liabilities $53,314,384. The difference between the two equates to only $6,441,365. In contrast to previous years you will see the difference between its assets and liabilities was significantly greater. This can be attribute to the $36,914,021 in "Goodwill" that was no longer deemed to have any relevance. According to ESOA's 10-K, "Based on our continued operating losses and management's forecasts of future cash flows our goodwill impairment test indicated that the goodwill of the Company had no value."

Figure 4: ESOA's Balance Sheet Value

Firm Specific Risks: Quantitative & Qualitative

Despite ESOA's significant decline in its market value per share, historical patterns of volatility are relatively low. ESOA reveals a firm-specific beta value on only 1.27, which is slightly above the market beta level of 1.0. To analyze ESOA's firm-specific risk, I used its holding period returns with distributions for approximately the past six years (2006-Present) in order to compute the sample estimates above in both normal and logarithmic form. For accuracy and effort towards eliminating error in computing the sample estimates, I used the same methods in all calculation and retrieved equivalent data with identical number of observations.

Figure 5: ESOA's Risk Metrics

In figure 5, notice the variation between ESOA's sample estimates for the HPR (normal) and HPR (logarithmetic). The deviation between the artihmetic average for both computations is quite significant. ESOA's normal arithmetic average return for this period was 10.98% where as the logarithmic return was 3.60%. Note "Arithmetic Average" was computes using weekly data and therefore has been adjusted to represent the annualized return for both HPR normal and logarithmic. Also note the logarithmic HPR was first computed by deriving the relative return for each individual HPR, which is simply (HPR+1). This ensures all values are positive prior to computing the logarithmic value of each number. The standard deviation, simply the fluctuation in percentage terms of the securities market price per share on a time noted basis, is high at 6.73%. This is high in contrast to an average market index fund, which would be approximately 1.5% over the same period, however taking into account the industry in which ESOA operates this is merely a small area of concern. Engaged in an environment where a competitive bid process is used regularly to gain customers for contracts indirectly will augment this value. The kurtosis value revealed in ESOA's holding period returns does not surprise me given its historical trend, however it is an area of concern. Kurtosis is useful in determining the degree of peak in a distribution to help determine the likely hood of extreme outcomes. To some this simple computation may appear to be an obscure measure with little importance, however it was the failure to analyze metrics as such that results in failing to recognize the extreme probability of an even such as the 2008/2009 credit crisis from occurring.

In addition to the quantitative risk metrics involved with ESOA, there are firm-specific qualitative risk factors that need to be assessed as well. As I previously mentioned, I addressed concerns regarding ESOA's backlogged work, issues resulting from an inadequate capital structure, and several off-balance sheet items, but the core firm-specific risk facing ESOA is its working capital available. Excluding adverse weather conditions, the other primary factor affecting ESOA's operations its capital available to complete projects and this is clear through its history of backlogged work. Going into FY 2013, it will be imperative ESOA seeks alternative methods of financing in order to be capable of sustaining operations.

Conclusion

ESOA is a company if given the appropriate changes to its capital structure and financing decisions has the ability to make a turn around in the industry. Capital adequacy for funding projects and complications surrounding debt financing are the key underlying issues that initiated a sell off by market participants with high uncertainty. In conclusion, ESOA is a speculative investment that needs critical attention as it has the potential to provide investors with magnified gains, however substantial down side risk is prevalent with any firm that is not turning over a profit.

Sources: TD Ameritrade, YCharts, Google Finance, Yahoo Finance, and The US Securities and Exchange Commission Website.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.