08/16/2017

Stocks to Buy and Sell Based on Expectations

Stocks to Buy and Sell Based on Expectations

Much of the recent content we have been publishing has been geared around our Value Expectations interface which harnesses the strengths of AFG’s proprietary Economic Margin framework and modified DCF model to better understand the embedded sales growth expectations a stock must deliver to justify its current price. This process allows investors to spend more of their due diligence time focused on stocks with low expectations for sales growth and avoid companies with high expectations relative to what the company has delivered historically.

Today, we will focus on the sales growth expectations embedded in stock prices for individual companies within the S&P 500 to identify those that have low expectations as well as a few with lofty expectations. By understanding the sales growth “priced-in” relative to what the company has delivered historically, you can set a “hurdle rate” to determine whether or not expectations can realistically be met. When expectations are low companies tend to be more likely to outperform those expectations and outperform their benchmarks.

The companies from the S&P 500 listed below have been identified as having either very lofty or very low expectations for sales growth relative to what they have delivered historically, and relative to the expectations of their sector and index peers. The companies with low expectations for sales growth also earn an Investment Grade of “A” which means the company receives the highest grade in our model based on Valuation, Quality and Momentum factors. The opposite is true for the companies we have identified as having high expectations for sales growth, these firms currently earn an Investment Grade of “F”.

S&P 500 Companies with High/Low Sales Growth Expectations

COMPANIES WITH HI AND LOW EXPECT 8-9-16

 

To illustrate this concept, we will take a look at one of the companies from our list of “A” Grade companies with low expectations, Endo International (ENDP). ENDP is currently trading at around $22 a share. By assuming EBITDA margins and Asset Turns remain near their 5 year median levels, ENDP needs to deliver around -26% Sales Growth over the next 5 years to justify its current price. In other words, ENDP has extremely low sales growth expectations priced into its stock in relation to what it has been able to deliver historically.  Even when the assumptions for EBITDA and Asset Turns are manipulated to reflect a much more conservative outlook, ENDP still has very low expectations for growth “priced-in”.

endp img

By focusing your time and effort on companies with low expectations for growth “priced-in” to current trading levels, that also earn an Investment Grade of “A”, money managers can develop a focus list of companies that have many characteristics inherent in companies likely to outperform benchmarks and sector peers. Once you have identified your focus list, you can also utilize the Value Expectations interface to build out extremely detailed pro-forma financials, determine a target price based on your own assumptions and also stress test your valuation assumptions.

About Chris Austin 2 Articles

Partner at The Applied Finance Group
Focus areas:  Portfolio Consulting, Business Development
Joined AFG in 2003

About Chris Austin 2 Articles

Partner at The Applied Finance Group
Focus areas:  Portfolio Consulting, Business Development
Joined AFG in 2003