Posts Tagged ‘AAWW’

Overselling of Risk for Certain High Beta Stocks

June 2nd, 2010 Comments off

Investors have been selling risk. This is not uncommon during periods of uncertainty, but is rare when the economy is just a year or so out of recession, when earnings and cash flows are expected to rise over the coming years.

When this risk divergence occurs, undervalued and oversold equities often result in large returns compared to other asset classes, as well as stocks in general. Investors, who assign risk based on beta, rather than on fundamental factors, may not be properly calibrating the credit health of the entity.  The list below was assembled with those investors in mind, who believed they were selling (or avoiding) risky assets, when in fact, they were not.

The list was run for entities which are value adding, that is, they have a higher return on invested capital than their cost of capital. After all, that is the primary responsibility of corporate executives. These firms have lower than average leverage, even when including operating leases and pension underfunding. For firms which have seen their operating leases growing by greater than 5% per year over the past 5 years, we assumed such growth would continue, instead of using the GAAP mandated 5-year minimum signed lease obligations. These firms have also been generating positive free and operating cash flows, although over the short-term, even firms in distress tend to produce free cash flows as they take any and all actions to produce maximum cash. Obviously, this can only go on for so long.

Although these firms appear undervalued, they may not be appropriate to all investors, hence strongly urge you do your own due diligence. They would appear, however, as a group, to offer significantly greater value, than the equity market in general.

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