Sophisticated stock ranking

Steve Marcus

Applied Finance Group of Fresno gives Wynn Resorts Ltd. a wealth creation ranking of five stars.

By Liz Benston (contact)

Monday, Oct. 13, 2008 | 2 a.m.

It’s hard to believe, with the stock market sinking like the Titanic and gaming companies floating to the bottom like so much debris, that there’s more to investing than fixating on a company’s share price.

At least there should be, according to Applied Finance Group, a Fresno-based company that crunches numbers for more than 200 clients, including hedge funds, mutual fund companies and corporations.

The battered Las Vegas market, home of several publicly traded companies as well as the flagships of a still-young American gaming industry, is in need of some rational analysis.

The folks at Applied Finance obliged, disclosing publicly for the first time evaluations for which its clients pay thousands of dollars.

(The accompanying chart shows Applied Finance’s ranking of all Las Vegas Valley-based companies with publicly traded stock, not just gaming companies.)

The rankings show that even though these companies have all been dragged down by a punishing stock market, they aren’t created equal.

“In every industry, you have winners and losers” just as you have buyers and sellers, Applied Finance co-founder Rafael Resendes said.

Applied Finance, whose investment clients manage more than $500 billion in U.S. stocks, isn’t an investment bank, so it doesn’t make money from the companies it covers, a potential conflict of interest.

Applied Finance ranked performance from one to five stars based on numerous factors, including the company’s ability to make money in excess of the company’s risk-adjusted cost of capital — what Applied Finance calls “economic margin.” Also measured was the ability to sustain economic margin over time, including a forecast of expected margins compared with a company’s peers.

The rating, which removes distortions created by accounting irregularities that have little to do with company performance, also grades the corporate management team.

The second major performance factor is stock price, but it’s more complicated than it sounds.

Applied Finance measures the upside or downside of investing in a company compared with its current share price. To do this, the firm forecasts the company’s expected cash flows, a measure of earnings before deducting certain items. Those cash flows are then subtracted from a company’s current cash flows.

Both economic performance and valuation are important considerations for investors, Resendes said.

A score of five means a company is a top wealth-creating performer; those with a score of one are destroyers of wealth.

According to the rankings, Bally Technologies is a “strong wealth-creating firm while at the same time attractively priced,” he said. On the other hand, Gaming Partners is an example of a “possible torpedo” lurking in portfolios because it is a “poor economic performer while at the same time overvalued.”

Shares in some companies listed as “fair value” — such as International Game Technology, Wynn Resorts and Las Vegas Sands — are trading around where they should be, based on their fundamentals, which would be a sign for investors to hold the stock.

Wall Street analysts recommend buying undervalued stocks and selling overvalued ones.

Some investors just look at company earnings, which offer a narrow snapshot by which to judge a company’s ability to grow the entire operation, Resendes said.

In the casino industry, some investors jump into companies they think will “explode” based on the prospect of gaming legalization or the addition of slots or other games based on regulations, Resendes said. Sometimes the market will pay a premium for a stock based on those prospects.

And yet, companies with quality products and services may not be good investments because those performance forecasts are speculative, Resendes said.

“That’s where some investors get detached,” he said.