By Charles W. Robinson III, CFA (Guest Contributor)

The Risk Trade

As in the second quarter of 2009, the markets continued to reward riskier investments during the third quarter of 2009, with nearly all investment categories rising in value. Returns ranged from the less risky short-term U.S. Treasury bonds (~+1.5%) to emerging market bonds (~+11%), to classic large cap growth stocks (~+11%), to emerging country stocks and distressed stocks (~+30% and ~+40%).

In a recent Article by John Tamny, Forbes: To Fix The Global Economy, Fix The Dollar, the effects of a weakening dollar on the U.S. Economy were nicely summarized

When money loses value, it's the equivalent of governments raising the rate at which we pay income taxes. But with taxes, we can at least see how much the government is removing from each paycheck.

By David Lee Berkowitz (Guest Contributor)

As I write this letter, the third quarter has ended, in what continues to be an incredible year for the stock markets, the economy and the country. Unfortunately, the “regime uncertainty” I wrote about last quarter has not clarified. We still do not know with any more visibility than 3 months ago what the business landscape and the new regulatory rules of the road will be.

This article provides valuable insights as to what investment professionals are thinking about the current state of the market along with actionable Long/Short Investment Ideas. Our Market Forecast Project (MPF) surveys hundreds of money managers to gain a unique set of insights from those on the frontline of investing.

Listed below are the results of the 4th issue of The MFP survey with 19 market related questions, 160 unique equity ideas provided by participants as their favorite long and short recommendations (110 Long/50 Short), as well as MFP trend information which tracks the movements in investor sentiment from each issue of our survey.

By Oct 30, according to Dow Jones news, of the 344 companies in the S&P 500 that have posted Q3 results, 80% reported earnings above analysts' expectations, 6% matched and 13% below. In a typical quarter, 61% of companies beat estimates, 18% match and 21% miss. Q309’s outperformance has surpassed the highest percentage of companies reporting earnings above expectations for a quarter, which are 73% in Q209 and Q104 respectively. However, the S&P 500 lost 0.84% in October, breaking its streak of 7 consecutive monthly gains in 2009. (By the way, 53% of our September MFP survey participants nailed it when they predicted the S&P500 would return –3% to 3% in October). The pause the market took in October is interesting, as the market seems to have finally responded to concerns that valuation is getting rich and uncertainty abounds regarding the growth prospects of the US economy.

November has a cheerful start so far with the stock market on the rise again, although we were just informed unemployment rate increased to 10.2%, the highest in more than two decades. Warren Buffett’s “all-in wager” on the US economy - his announcement to purchase railroad operator Burlington Northern Santa Fe (BNI) in a $44 billion deal certainly helped to inject optimism and produced the rally. We don’t intend to bet against our country, which has produced more wealth since its inception than what the rest of the Mankind has produced in thousands of years of history.

The Applied Finance Group (AFG) is an independent equity research provider that has partnered with CEO Magazine in recent years to give investors insight into which CEOs do the best job of creating value for its shareholders; after all, that is what they are hired for.

The AFG/CEO Wealth Creation Index, which relies upon AFG’s corporate performance metric Economic Margin (EM), provides a better understanding of wealth creation than traditional accounting measures such as EPS and ROC. The link below will take you to the complete list of rankings of CEOs from S&P 500 companies that have held their current position for at least 3 years, based on their wealth creation abilities. Topping the rankings in 2009 is MasterCard’s (MA) Robert W. Selander, up from third place last year. Both Selander and runner-up Federated Investors’ (FII) J. Christopher Donahue run very high EM companies (24.5 percent and 20.6 percent three-year averages, respectively). Interestingly, both have been able to improve in a bad economy.

With 10 months of 2009 behind us and the holiday season approaching, we decided to highlight some of the companies that have driven the market rebound in 2009. The companies in the list below have earned the largest total returns thus far year-to-date in the S&P 500.

Even though these companies have done well, one should be careful of the stocks that have run up and are now overvalued. Listed below are the top returners in the S&P 500 (excluding financials) and how these companies rank according to The Applied Finance Group’s valuation model.

Below are the results our third Market Forecast Project Issue as well as the Long/Short ideas provided by participants.

Question 1 Results

With the biggest shopping season of the year just around the corner, we thought it would be timely to highlight some consumer sector companies that look attractive according to The Applied Finance Group’s (AFG’s) criteria for investment opportunity attractiveness, as they are in line to benefit from the upcoming seasonal spending patterns. The list of companies we have provided look the most attractive within the AFG consumer sector in terms of valuation attractiveness, economic performance, and overall investment attractiveness relative to their peers.

One of the companies that we feel particularly confident in is the retailer Kohl’s (KSS) which is currently a holding in The AFG 50, (a model portfolio of 50 large cap stocks designed to help Portfolio Managers save time, make more informed investment decisions, and outperform their benchmark). We are confident about Kohl’s competitiveness because they have a strong cash flow, strong execution, and have been outperforming their competition.

Question: Why Is Buffett The Wizard of Omaha?
Answer: (NYSE:BNI)

Analysis of Berkshire Hathaway's (NYSE:BRK.A) acquisition of Burlington Northern Santa Fe Corporation.

By Jeffrey Bronchick, CFA (Guest Contributor)

Not that anyone at RCB would need it, but upon the suggestion of a “friend,” I recently read (ok, re-read) Dr. Bob Rotella’s book, Golf is Not a Game of Perfect. Among the variety of frighteningly applicable lessons (to our friend) was the idea that many golfers continually beat themselves up over poor shots, yet when the 195 yard five iron to within two feet of the pin materializes out of nowhere, there is the tendency for the player to write that off as a “fluke,” or “lucky” or a disdainful “finally.” But again, I am merely passing on second hand information.

By Grey Owl Capital Management (Guest Contributor)

“Alice laughed. `There's no use trying,' she said `one can't believe impossible things.'

By Kai Petainen

Jim Cramer thinks AAPL (AAPL) is worth $300 and I think AAPL is worth less than $100. To borrow Jim Cramer's line, 'Where do I get this stuff?' I'll point it back at him and ask, 'Where does he get that stuff'? Perhaps all he did was multiply two numbers? I can multiply two numbers, I have a passion for the markets and I too am opinionated. Can I have a TV show too, please? Jon Stewart, would you like to multiply two numbers? You can do it too. I'll show you how. I'll come on your show and multiply them for you if you like.

It’s been a brutal period for wealth creation. Yet some CEOs have managed to improve their performance. In its second year, the wealth creation index developed by Chief Executive, Applied Finance Group, and Drew Morris, CEO of Great Numbers!, seeks to identify those business leaders who have done the best job of creating true economic value. The Index (see “Ranking CEO Wealth Creation,”) leans heavily on Economic Margin (operating cash flow less an appropriate capital charge over invested capital) as a metric to get at what really counts, which accounting measures such as EPS and even ROC are less able to do. Creating value is, after all, what the CEO is hired for. And as an objective measure of real value EM holds up better than most, even when share prices tank as they have over the last 18 months. To get a fair assessment of management’s impact on value creation, we only rank CEOs who have been in their jobs for a minimum of three years.

Topping the rankings in 2009 is MasterCard’s (MA) Robert W. Selander, up from third place last year. Both Selander and runner-up Federated Investors’ (FII) J. Christopher Donahue run very high EM companies (24.5 percent and 20.6 percent three-year averages, respectively). Interestingly, both have been able to improve in a bad economy. The projected EM for both companies for 2010 is close to 28 percent. To paraphrase the old Memorex TV commercial, is Selander’s success real or is it the business model? In other words, does MasterCard excel because of the leadership skills of Selander (and his team) or thanks to an operating system developed sometime in the late 1960s and honed since?

What If Anything Is Gold Saying?

Despite a small setback in the stock market at the beginning of September and the short lived media frenzy of how September has been historically the worst month of the year for investors, the S&P500 returned a positive 3.57% in September 2009, extending the rally for the 7th consecutive month this year.

The Applied Finance Group's (AFG's) Value Expectations (VE) interface is useful in understanding the imbedded sales growth a company needs to achieve over the next 5 years to justify its current stock price. Measuring the spread between a company’s imbedded sales growth expectation (Implied Sales Growth) and what it has historically delivered (5 year historical median) provides a basis to determine which stocks have relatively low expectations and thus are more likely to outperform.

When using the VE interface to solve for the implied sales growth for every company within the S&P500, we found that the average implied sales growth for the overall index is 4.94%. This is less than the S&P500’s 5-year median for sales growth of 12.25%, which would suggest the index is still undervalued. The chart below displays this comparison, as well as the implied sales growth vs. historical sales growth for each sector within the index.

The key benefit of using The Applied Finance Group's (AFG’s) Economic Margin Framework is that it provides a systematic approach to converting as-reported accounting data into a performance metric that is comparable across time, peers, industries and even countries while eliminating many of the accounting distortions inherent in GAAP. The ability to understand the true economic profitability and the underlying intrinsic value of a company using one consistent method is why AFG expanded its framework internationally. Now investors all over the globe can take advantage of the same institutional quality research and investment tools that AFG’s U.S. clients have been using since 1996 to better understand the expectations embedded in security prices and take advantage of mispriced securities in the market.

AFG uses proven proprietary criteria to identify firms that are more likely to outperform the benchmarks, and filter out those that are least attractive. These criteria include variables such as management quality score, earnings quality, firm valuation and economic performance metrics. AFG has proven through time in identifying winners and losers in the market through its buy and sell lists which continue to have a significant spread in performance between the buys and sells.

Among the many reasons given for spinning off a company, time and again managements tout promises to unlock value. Was that the case when Cardinal Health (CAH) released CareFusion (CFN) from its reins and allowed it to run free as a stand-alone publicly traded company that officially began trading on September 1?

After adjusting for what remains of CAH to account for total sales that are about 5% lower (despite a 33% drop in assets), CAH is still a dominant North American pharmaceutical and medical supply distributor. Since CFN accounted for the majority of capital expenditures, rental and research & development, (95%, 90%, and 99%, respectively), as well as virtually all of the international manufacturing and sales operations, CFN is characteristic of a growth company while CAH is not. Leaving with CFN were products in global markets, an innovation engine and high growth prospects, key characteristics necessary to compete in the medical instruments and supplies industry. Staying with CAH is a large distributor of drugs and supplies with national scale, negotiating power and single-digit growth.

Just as we did Friday for the S&P 500, for our small cap focused readers we are providing a list of the top 20 performing stocks in the Russell 2000 as well as a sector breakdown of the YTD returns from the index to keep up to date on which companies and sectors have lead the way thus far through 3 quarters of 2009.

Also by using The Applied Finance Group’s (AFG's) research and valuation model we have provided further analysis on 4 of the top performing companies, 2 that we find attractive going forward and 2 that we find unattractive, based on valuation attractiveness, expected improvement in economic profitability and the overall investment attractiveness, which is based on various criteria AFG uses when identifying long/short opportunities.

With 3 Quarters of 2009 now in the books, we thought it would be timely to provide a list of the top 20 performers in the S&P 500 so far this year to give investors an idea of which stocks have been doing well. Along with the list of top 20 performing companies, we have also provided a breakdown of the average return by sector as defined by AFG vs. the entire S&P 500 index to show which sectors have been leading the way.

Also by using The Applied Finance Group’s (AFG's) research and valuation model we have provided further analysis on 4 of the top performing companies, 2 that we find attractive going forward and 2 that we find unattractive, based on valuation attractiveness, expected improvement in economic profitability and the overall investment attractiveness, which is based on various criteria AFG uses when identifying long/short opportunities.