Avoid These Wealth Destroying Companies – Including FedEx Corp. (NYSE:FDX) And Alcoa Inc. (NYSE:AA)

When screening through a list of possible companies to own in an investment portfolio, it is important to have a repeatable process with a strict set of guidelines in order to continuously identify companies likely to outperform. An important component of our process of identifying the best stocks to own begins with eliminating potential torpedoes from our constituent list. One tool we utilize as an exclusionary metric is Management Quality which identifies companies that investors may want to avoid as they have management teams that are attempting to grow their businesses when they are not profitable.

To understand if a company truly is profitable, we use the Economic Margin methodology. Economic Margin (EM) measures the return a company earns above or below its cost of capital. This measure considers three important factors; 1) the amount of Cash Flow a firm is generating, 2) the capital base from which the cash flow is derived, and 3) the opportunity cost of employing that capital.

By understanding the true economic profitability a company is earning, we are able to see more clearly how adept a firm’s management team is at creating wealth for its shareholders. Firms with positive EMs are generating Operating Cash Flow beyond the cost of the capital employed, thus creating investor wealth. These firms should maximize their profit opportunity by expanding their capital base.

If a firm cannot earn back its economic cost of capital (negative EM), it should not be growing its asset base. Instead, the company needs to concentrate on the parts of their company that have been creating wealth, fix the broken parts of its business by divesting losers, and work on improving profitability to earn the right to expand.

The charts below illustrate the performance of all of the companies in the S&P 500 grouped into two buckets, wealth destroyers (bottom half) and wealth creators (top half). Wealth creators are firms that have positive EM and are growing their business while wealth destroyers are firms with negative EM and are growing their business.

You can see that over the past year (12/2012 to 12/2013) and since we began tracking the performance of this metric (9/1998 to 12/2013) that many torpedoes can be avoided simply by eliminating companies that destroy wealth from your list of constituents.

The 14 companies listed below all are following the path of wealth destruction by attempting to grow while not earning back their cost of capital. Pay extra close attention to these companies if you own them or plan on adding them to a client’s portfolio. These companies also look unattractive overall according to our valuation model and Investment Grade metrics. Be careful with these potential torpedoes.