CSCO

The list of most actively traded stocks in the S&P 500 seems to attract the most attention amongst the investment community and always create a good amount of “Buzz”. We decided to take the list of the most actively traded stocks over the last 50 trading days (excluding financials) and run them through The Applied Finance Group’s (AFG’s) meat grinder to see which are worthy of the hype and are attractive investment opportunities and which you should probably stay away from.

AFG uses a set of criteria in its stock selection process that has proven successful at identifying winners and losers in the market including its proprietary measure of corporate performance (Economic Margin), valuation, management quality and earnings quality among other criteria. Of the companies listed that are heavily traded, AFG believes the companies with expected improvement in Economic Margins, attractive valuations, and a wealth creating management team are the companies that will be the most likely to outperform the market and their sector peers. (register now to receive exclusive buy ideas- it's fast and free!)

The rankings above were provided using AFG’s research product AFGView.com and are ranked based on AFG’s overall investment opportunity signal, valuation signal and expected changes in Economic Margins. The companies must rank as attractive or unattractive in all 3 categories or the firm is listed as neutral.

Below is a brief description of those variables with informative links.

Source: EconomicMargin.com

AFG's Valuation Metric – Measures the percent to target (deviation between a stock’s current trading price and its AFG current default target price). To derive the intrinsic value of a firm, AFG uses its proprietary Valuation Model (modified discounted cash flow model).

Economic Margin - A corporate performance measurement that addresses the gaps in GAAP, eliminating distortions caused by accounting policies to measure what a company is truly earning above or below their cost of capital.

Management Quality – Assesses management’s ability to make wealth creating decisions.

+View our List of Value Expepectations Recommended Articles

AFG Recommendation Performance
9/1998 – 5/2009
Annualized Returns

Source: AFGView client databases from 9/1998 – 5/2009
Universe size: 4,000 to 5,500 firms

The Applied Finance Group’s (AFG’s) valuation technique helps investors identify and take advantage of mispriced securities in the market. One way investors can identify over or undervalued stocks is by using AFG’s Intrinsic Value Chart, which displays a company’s intrinsic value relative to its trading range and helps entry/exit points.

This easy to read chart identifies how far a stock’s trading range deviates from its intrinsic value (target price assuming immediate decay), which helps you recognize potentially mispriced stocks and pursue long and short opportunities. AFG’s Intrinsic Value Chart also contains a company’s Value Score (ranked valuation attractiveness), Economic Margin Change (expected improvement of economic profitability), and Accuracy (how well AFG’s default valuation has tracked the company) information. AFG’s valuation framework estimates a company’s equity value by subtracting debt and other liabilities from the total enterprise value. The total enterprise value is estimated by discounting projected future cash flows, utilizing analyst consensus, Economic Margin methodology, and the Decay concept which addresses the perpetuity bias in the traditional DCF model.

AFG’s Intrinsic Value Chart:

• Identifies entry/exit points

• Shows how well AFG has tracked the company (accuracy)

• Displays the trading range of the company each year through time (blue bars)

• Displays the end of year closing price (dash on blue bar)

• Displays AFG’s default intrinsic value (red dotted line)

How to Read this chart:

• The Blue Bars represent the high and low trading range for a stock for each calendar year.

• The red dotted line represents Applied Finance Group’s (AFG’s) historical Intrinsic Value through time.

• When the red line (Intrinsic Value) is above the blue bars (trading range) the company looks to be undervalued.

• When the red line (Intrinsic Value) is below the blue bars (trading range) the company looks to be overvalued.

Below is an example of AFG’s Intrinsic Value Chart and the important things to look for within the chart as well as two examples of undervalued companies according to AFG’s Intrinsic Value Chart as well as two overvalued and two fairly valued examples to provide a better understanding of what to look for when analyzing AFG’s Intrinsic Value Chart.

What to look for in AFG's Intrinsic Value Chart:

2 examples of undervalued companies (ABT,WAG) according to AFG's IV Chart:

2 examples of overvalued companies (BDK,MYL) according to AFG's IV Chart:

2 examples of fairly valued companies (CSCO,SNDK) according to AFG's IV Chart:

Click Here for an example of how we have used Intrinsic Value.

Every year Fortune releases a list of the 40 best companies to invest in now to retire on. This long-term portfolio is designed to protect your hard-earned nest-egg as you approach retirement.

Last year Fortune’s portfolio of 40 best stocks to retire on returned -23.07% from 6-20-08 to 6-16-09, relative to the -30.8% returned by the S&P500 during the same time period. This year they are replacing 23 stocks to form the new portfolio.

Provided below are the 40 stocks recommended by Fortune as the best stocks to retire on in 2009 and our outlook of these companies from a valuation perspective based on The Applied Finance Group’s valuation model.

 Fortune's 40 Best Stocks to Retire On - 2009

Related Stock Article:
Is Apple a Buy Hold or Sell?, Click Here to View

In March, Jim Jubak of MSN Money released a list of stocks that he believed should be stocks that you should pay attention to in the upcoming months/quarters as potentially attractive investment opportunities. ValueExpectations.com set out to answer the question, which stocks on Jim’s watch list look attractive according to AFG’s valuation model and should be on your watch list?

Provided in the table below are Jubak’s watch list companies and how they fare from a valuation perspective using The Applied Finance Group’s Value Score variable which ranks the valuation attractiveness of each company based on the discrepancy between the company’s current trading price and AFG’s target price.

Jubak's Watch List Companies (Ranked by Valuation Attractiveness)

Valuation Model – Using AFG’s modified discounted cash flow model to measure the intrinsic value of a firm compared to its peers.

AFG's Value Score - A score which represents the ranked percent to target (deviation between stock’s current trading price and AFG’s current default target price) or attractiveness (upside) relative to the universe. A Value Score of 100 is the most undervalued and 0 is the most overvalued company in the universe.

Fortune released a list of 40 companies in June 2008 that they labeled as the 40 best stocks to retire on. Although ValueExpectations.com’s research is focused on long-term investing, we believe reviewing companies on a ongoing basis helps to avoid potential pitfalls with bad investments and allows one to take advantage of companies that might be mispriced. For this reason we have ranked all companies in the Fortune 40 portfolio based on Valuation Attractiveness.

Good companies don’t always make good investments! If you believe this is a list of quality companies then that is a wonderful start. But understanding what you are paying for those companies is equally important. Few would argue that Mercedes Benz produces an excellent engineered vehicle and a quality product. However, if that Mercedes Benz cost $1,000,000, it may be a great vehicle, but not necessarily a good price.

As a review of the performance of this list since release, Fortune’s portfolio has returned an average of -28.64% since its release which is about 6.3% spread above what the S&P 500 delivered on average during the same time period. Although this portfolio did outperform the S&P 500, had you invested in these 40 companies in equal parts on the date of release, your $100,000 retirement nest egg would now be worth somewhere around $70,000.

Fortune 40 Companies To Retire On

AFG's Valuation Model – Using AFG’s modified discounted cash flow model to measure the intrinsic value of a firm compared to its peers.

Tickersense.com has recently published an article highlighting 15 companies that have been the leaders of the market since the low on November 20, 2008. Made up mostly of Tech stocks (8 of 15), this list of companies has been responsible for about half of the total change of the S&P500 since November 20, and the author believes it is a good place to start if you are “looking for leadership”. Below is a table highlighting the price performance of 12 of the 15 companies (Financials were excluded as well as WYE and SGP due to takeovers).

A second table provides an analysis of the valuation attractiveness of these companies as well as the market expectations for sales growth implied in the stock’s current price using AFG’s Value Expectations interface. Measuring the spread between a company’s VE sales growth expectations and what it has historically delivered should give you a good idea of which companies have the best chance of meeting or exceeding those expectations, and thus are more likely to outperform.

 Performance From November 20, 2008 to Yesterday's Close

Valuation Attractiveness & Implied Sales Growth Expectations

*AFG’s Value Expectations allows us to understand the Sales Growth, EBITDA Margin, and Asset Turnover a company has to deliver in the future to justify its current trading price. In theory and in normal circumstances, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued. The table displays the implied future Sales Growth of the list of companies assuming their EBITDA Margins and Asset Turnovers stay at the 5 year median levels.

As 2009 approached, USA Today’s market experts gave us their insights/predictions on what they thought would happen in the upcoming year. Even as the world has changed dramatically since this list was released in December 2008, these “guru’s” picks are worthy of some attention to see how their predictions did against the overall Russell 1000 index so far this year. We ran their list through Applied Finance Group’s (AFG’s) set of screens that identify potential investment opportunities to see which companies they recommended met AFG’s criteria. Below is each expert’s picks and performance along with the performance of the Russell 1000 to benchmark against. The 6 companies highlighted (TAP, CSCO, WMT, PG, ABT, JPM) were the companies that met AFG's Buy Criteria (described below) for a potential investment opportunity and the rest failed to make the grade.

USA Today's Investment Pros - Picks For 2009

USA Today's Investment Pros Picks Vs. Russell 1000 - December 12, 2008 to March 17, 2009

A brief description of The Applied Finance Group's Buy Criteria variables is below:

Economic Margin - A corporate performance measurement that addresses the gaps in GAAP, eliminating distortions caused by accounting policies to measure what a company is truly earning above or below their cost of capital.

Valuation Model – Using AFG’s modified discounted cash flow model to measure the intrinsic value of a firm compared to it's peers.

Management Quality – Assess management’s ability to make wealth creating decisions.

Related: Read our Economic Margin white paper which was published in the book: Value-Based Metrics: Foundations and Practice Edited by: Frank J. Fabozzi and James L. Grant Pages 157 – 178: Click Here

Fortune magazine recently put out an article listing the most admired companies in the world.  We took the top 50 firms (excluding Financials, and companies not traded in the US) on their list and put them through Applied Finance Group's quantitative recommendation framework.  Just because these firms are among the most admired companies in the world does not qualify them as the most attractive investment. Being among the most admired is an honor and means you must be doing something right, but might not necessarily mean the share price is currently attractive. 

The following articles which we have posted in the past on ValueExpectations.com will give you a better understanding of what it takes for management to create wealth, understand Management Quality, and see how EPS alone falls short in estimating a company’s value. There are two main characteristics a company must have in order to be a good investment opportunity: (1) the company needs to be a strong economic performer, (2) the company should be attractively priced.   Many people admired the DeLorean, but it was neither a good performing car nor a good priced car. Below we reveal a few "DeLoreans" after looking under the hood.

Top 50 Most Admired Companies According to Fortune

The tech sector has been taking a pretty bad beating the past few months but according to Bill Luby of SeekingAlpha.com, The 4 Horsemen of Tech (RIMM, AAPL, GOOG, AMZN) will be the most likely companies in the sector to make the strongest comeback when the tech sector makes a comeback. Here is a list of many of the big names in tech and the implied sales growth expectations priced-in to justify their current price. The companies with low sales growth expectations priced-in (VE Sales Growth) compared to what they have been able to deliver in sales growth (5 Year Median Sales Growth) are the companies we believe have the best chance of making a strong comeback with the sector.

According to historical valuations the tech sector appears to be trading at a discount compared to historical valuations such as the Tech Bubble.

Big Tech Companies and Sales Growth Expectations

For the past 26 years Steven Halpern, editor of thestockadvisors.com has gone to well known and respected advisors once a year to find out which stocks they like for the coming year. Take a look at the list of stocks advisors liked in 2008 and their performance. Also listed are the picks of 75 prominent advisors for 2009 along with sales growth expectations for the companies to justify their current price (VE Sales Growth) which can be compared to what they have delivered in revenue growth over the past 5 years(5 Year Median Sales Growth). These companies are worth a look because they are in favor of well-respected advisors, but the companies that also have low expectations for sales growth priced-in to their stock are especially worthy of a close review.

2008 Blogger Picks Conservative and 2008 Performance

2008 Blogger Picks Speculative and 2008 Performance

Blogger Picks for 2009 and Sales Expectations

* denotes # of years historical sales numbers available

VE Sales Growth calculated for these firms on 1-6-09

Over the years, The Applied Finance Group has made thousands of calls regarding stock valuations and whether they should be buy or sell candidates. More often than not, our calls have tended to work out and add value to our clients’ portfolios. Chart 1 below shows the cumulative performance of theoretical portfolios that consist of the most under and over valued stocks in the Russell 1000 and Russell 2000 indices. The main take away, is that over time our valuation approach has delivered superior results identifying Buy and Sell candidates for professional investment managers.

Chart 1

While our results are impressive, we have had periods of poor performance, most notably during the period of “irrational exuberance” of the late 1990’s, specifically from January 1999 to June 2000. During this period chart 2, summarizes our performance over this time period. Notice that this period, “over-valued” stocks performed much better than “under-valued” stocks.

 Chart 2

Proudly, I can say we never panicked about our under-performance during this time period. Unlike many investment research firms, we did not justify crazy company valuations. Back then, new research firms sprung to life everyday preaching how the world was fundamentally changing, and declaring that measuring corporate performance and understanding valuation were relics of the past. As irrationally optimistic about a “new world” as the market was then, today’s market suffers from excessively irrationally pessimistic beliefs about the future. As a picture is worth a thousand words, we thought it would be instructive to show our Intrinsic Value Reports for numerous high profile firms in early 2000. Understand that these charts are the exact charts our accessed in April 2000. While it is easy now to say Cisco was over-valued, our work showed how nutty that market really was back then when even dentists gave you a hot stock pick with every cleaning.

The following charts display our intrinsic value estimates for a number of high profile firms in April 2000. Looking at these charts, it is easy to understand why our research underperformed during this time period. Charts 3, 4, 5, and 6 show our January 2000 Intrinsic Value Reports for Cisco, ADBE, IBM, and Oracle. 

Chart 3

Chart 4
 

Chart 5

Chart 6

Notice that prior to 1999, our estimate of these firms’s intrinsic value (the green square) and their annual trading range (blue bars) closely followed one another. Starting in 1999, the valuations for these companies far exceeded our estimates of their intrinsic values. In almost every case by 2000 these firms traded at over three or four times our estimate of their intrinsic values. In the case of Cisco, we estimated its value in 2000 at approximately $11 a share, but during the year it traded over $80 a share. Once during a meeting with a “new age” portfolio manager, after pointing out how crazy Cisco’s valuation was he said to us: “AFG has 1 vote regarding Cisco’s valuation, the market has placed over 500 billion (he was referring to Cisco’s market cap, with each dollar being a vote) votes saying AFG is wrong”. He then promptly said, “You are wasting my time” and asked us to leave.

As mentioned earlier, It is easy to see how our research under-performed during this time period, we said Cisco was worth $11 a share, and in the course of two years it went from $11 a share to $80 a share. While we did not panic, we certainly were not very popular in the money management community, but we stuck to our guns and continued to advise clients and prospects to reduce their positions in these shares. Fortunately, by 2001, Cisco’s stock price corrected to our intrinsic value estimate of less than $10 a share. The same pattern was evident for each of the other firms charted above. The excessive valuations exhibited by these firms in 1999 and 2000, corrected towards their intrinsic value by 2002.

Let us examine the market, and revisit the above companies in today’s environment. The graph below shows the sales expectations priced into the S&P 500 over time. What is interesting is how pessimistic the market is today relative to the past ten years. Notice that in 2000, it was priced to generate sales of over 18% annually, today it’s only priced to grow at -5% annually. This implies that five years from today, the typical firm in the S&P 500 will have 25% lower sales than they do today! That seems a bit harsh.

On a company specific basis, Charts 7, 8, 9 and 10 show our current Intrinsic Value Reports for ADBE, IBM, and Oracle.

Chart 7
 

Chart 8

Chart 9

 Chart 10

It is interesting how the market has come full circle since 2000. Back then, the market refused to believe that the excess profits firms generated during those heady days would eventually mean revert towards their long-term average of zero. Today, the market refuses to acknowledge that the negative economic profits many firms currently generate will trend up towards their long-term average of zero. While the market’s valuation level is very different now relative to March 2000, one thing remains certain – following the market’s manic ways rather than thinking rationally on your own will consistently result in sub-par returns for your portfolio.

To help you keep your sanity, we have put together a screen of stocks trading below their intrinsic value. These are companies that have the opportunity to deliver superior longer-term returns as the economy recovers and corporate profits return to more normal levels. Take heart however, as today’s pessimism provides investors a great long-term buying opportunity to purchase great companies such as Cisco, ADBE, IBM, Oracle and others that are trading well below their intrinsic value.

Registered members that are logged in can download here:
You can download sample of such firms from a screen we created here.

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