Money managers ignored economic profitability and bought stocks that dropped the most in the credit crisis, leaving opportunities for value investors in 2010. Smart managers are buying this year’s laggards, betting companies with the highest EVA will be rewarded as the Federal Reserve prepares to raise interest rates and the government removes stimulus.
According to Bloomberg.com using data compiled based on consulting firm Stern Stewart & Co.’sEVA model less than one half (about 215 companies) in the S&P 500 had postive Economic Marginsin 2009 as the U.S. economy experienced the worst contraction since the Great Depression.
As the economy moves from the brink of collapse and companies that were given up for dead - the ones that fell the most through March 2009 - are going to have to do more than just survive. This "bounce back" effect is the reason that negative economic margin firms have risen the most. But in 2010 the bet will be that companies with the best EVA performance will out-perform as the recovery takes hold.
Joel Stern, the CEO and chairman of Stern Stewart & Co. reminds Bloomberg readers this morning that changes in EVA are four times likely to rise and fall with share prices than per-share earnings.
EVA, also known as economic profit, is a more reliable gauge of management performance because it treats the price of intangible assets such as research as an investment, while measuring all returns against the cost of raising money for the business, according to Stern.
The argument that “earnings per share is a driving force on value fails in the face of actual evidence,” he said. “It’s not earnings or dividends that create value, but economic performance.”
BERK: We clearly overshot on the down-side as panic about solvency reached its crescendo in March. Going into 2010 those companies with relatively high economic profitability and a low stock price relative to its value should do best going forward.
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