Intrinsic Value Investing: Recognizing Potentially Mispriced Stocks

by: Value Expectations

Rick Newman with U.S. News and World Reports put together an interesting piece about 15 companies that may not survive 2009 because these firms all carry large amounts of debt with very little cash on their books. These 15 firms all have been labeled with "very high" credit risks by Moody's.

By using The Applied Finance Group's (AFG’s) intrinsic value chart, one would have identified many of these companies as possessing great investment risks, long before they became red flags among the masses. Let's take a look at what AFG thinks of the 8 publicly traded firms by using AFG’s Intrinsic Value Chart and a brief explanation of the chart.

AFG’s Intrinsic Value Chart: identifies how far a stock’s trading range deviates from its intrinsic value (target price assuming immediate decay), which helps you recognize potentially mispriced stocks and pursue long and short opportunities.

• The Blue Bars represent the high and low trading range for a stock for 1 year.
• The red dotted line represents Applied Finance Group’s (AFG’s) historical Intrinsic Value through time.
• When the red line (Intrinsic Value) is above the blue bars (trading range) the company looks to be undervalued.
• When the red line (Intrinsic Value) is below the blue bars (trading range) the company looks to be overvalued.

AFG’s Intrinsic Value Chart also contains a company’s Value Score (ranked valuation attractiveness), Economic Margin Change (expected improvement of economic profitability), and Accuracy (how well AFG’s default valuation has tracked the company) information.

A quick takeaway from the charts is: From AFG’s perspective, Trump Entertainment Resorts (TRMP), Sirius XM Radio (NASDAQ:SIRI), Six Flags (NYSE:SIX), and Rite Aid (NYSE:RAD) shares are currently worth nothing. Krispy Kreme's (KKD) intrinsic value is below its latest trading price. Dollar Thrifty Automotive Group (NYSE:DTG), BlockBuster (BBI), and Landry's Restaurant (LNY) shares appear to be worth more than where they are currently trading.

AFG’s valuation framework estimates a company’s equity value by subtracting debt and other liabilities from the total enterprise value. The total enterprise value is estimated by discounting projected future cash flows, utilizing analysts' consensus, Economic Margin methodology, and the Decay concept which addresses the perpetuity bias in the traditional DCF model. In the case of TRMP, SIRI, SIX, and RAD, those companies are so leveraged that the values of their future cash flows are not sufficient to pay off their debt obligations.

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