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Economic Margin ™ -
Measuring Corporate Performance and Valuation
Toreador Research and Trading incorporates The Economic Margin Framework, developed by The Applied Finance Group, as a tool to analyze thousands of companies everyday on a consistent basis. The Economic Margin Framework is more than just a performance metric, as it encompasses a valuation system that explicitly addresses the four main value drivers of enterprise value: profitability, competition, growth, and cost of capital. Unlike traditional valuation approaches that utilize highly sensitive perpetuity assumptions, our approach incorporates the widely accepted economic principle that competition will compete away excess returns over time. The EM Framework explicitly models the effects of competition to gradually eliminate the excess spread a firm generates above or below its cost of capital.
Our research provides evidence of four factors that tend to explain the length of time that the market will pay for companies to generate returns above/below its cost of capital. For example, our research suggests that companies with high excess returns are likely to attract competition in the marketplace, requiring a shorter competitive advantage period in the company's valuation. Subtle insights such as these are just not achievable with traditional valuation models that rely on terminal values and perpetuities. Beyond being grounded in widely accepted economic theories of Noble Prize winners Merton Miller and Franco Modigliani, our valuation approach is used to identify companies trading above or below their intrinsic valuations, across sectors, market capitalization groups, and growth/value universes.
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Investment Process Overview
The Toreador Large Cap Focus Fund seeks long-term capital appreciation by investing primarily in stocks of large capitalization companies.
The advisor selects stocks it believes will offer superior return potential by focusing closely on the following factors:
Superior appreciation potential as measured by the difference between a company’s trading price and the advisors estimate of its intrinsic value
Attractive short and long term earnings quality
Trends in a company’s economic performance, such that it is consistent with improving shareholder value
Corporate wealth creation strategies to ensure management is running the company for its owners, not itself
We evaluate companies through our own rigorous analysis process based on our experience in the following areas:
Economic Performance: Financial statements distort economic reality and our first step is to recast a company’s financial information so it reflects a firm’s true performance.
Intrinsic Value: Common multiples such as P/E, P/B, and others fail to explicitly deal with profitability, growth, risk, and competition. For that reason, we explicitly address each of these issues in our discounted cash flow model to understand the intrinsic value of each company in our universe.
Management Quality: Absent a management team that understands how to create shareholder value, a “cheap stock” is likely to get cheaper. We score each company’s management team on how its strategy links with its economic reality. Our process is designed to flag firms such as Enron and MCI as wealth destroyers well in advance of their bankruptcies.
Earnings Quality: Companies have an amazing degree of latitude in preparing their financial statements. As a result, a dollar of net income may not represent a dollar of cash flow. We score the quality of each company’s earnings to determine which are or are not sustainable into the future.
After applying these factors to our universe of stocks, analysts review each company across various dimensions, such as:
Competitive position
Legal environment
Recent management changes
Growth opportunities
Acquisitions and Strategic direction
The analyst role is to look at these and other factors not captured in simple accounting numbers to find reasons not to buy a company that looks good “by the numbers”.
We believe our process is a unique and powerful differentiator that sets Toreador apart from any other investment advisor.
Please keep in mind that past performance is no guarantee of future results. Your Fund shares, when redeemed, may be worth more or less than their original cost.
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