RDC

In recent weeks we have written several blogs (S&P 500 sector stock watch, Attractive stocks under $35, with potential investment opportunities, Solid S&P Value Companies, Cheapest Stocks In the S&P 500), discussing investment opportunities within the S&P 500. These stocks ideas all had favorable scores under The Applied Finance Group's (AFG’s) investment criteria, which includes economic performance, valuation, earnings quality and management’s ability to create shareholder wealth, among other criteria.

Another way that AFG identifies potentially attractive investments is through the use of its Value Expectations interface, which helps investors get a better understanding of the expectations embedded into stock prices. This interface 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 below displays the implied future Sales Growth (“Priced-in Sales Growth) of the companies we have recently recommended in our recent blogs, assuming their EBITDA Margins and Asset Turnovers stay at 5-year median levels.

For those Valueexpectations.com readers who consider themselves value oriented investors, we have provided a good starting list of solid value companies that look attractive as potential investment opportunities for the long term. This list is a good place to start when looking for potential companies to add to your portfolio. The Applied Finance Group (AFG) considers companies with a Market Value/Invested Capital (MV/IC) in the bottom half of the universe as value companies.

To come to our list of attractive potential value plays, We ran those companies in the bottom half of MV/IC through AFG’s buy criteria that includes Economic Margin (How profitable they are), Valuation, Management Quality (how well management is running the business) as well as other quality checks to ensure that these companies are the most likely value companies to outperform. All 10 of these companies ranked above their sector peers in expected improvement of Economic Margins and in valuation attractiveness which has proven to be a good starting point when looking to identify companies likely to outperform their benchmark.

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.

Investors are always looking for an edge, a way to improve their stock selection process in the hope that it improves their overall performance. Fundamental investors may flirt with the idea of adding a technical overlay to their process while a value investor may take more of a chance on a growth company. No matter what style of investor you are, you want to be sure the process you are implementing makes sense.

Because of the volatility of the market, investors seem to be paying more attention to the technicals of the companies they hold or are considering to buy. While there are several ways technical analysts look at the momentum in the market, ValueExpectations.com will concentrate on the simple, yet widely used 50 and 200 day moving averages relative to a companies current trading price.

We, at The Applied Finance Group (AFG), believe that technicals are relevant, but it is much more important to focus on the fundamentals of a company in determining which securities are over/under valued. We have taken the S&P 500 and focused only on the stocks trading above their 50 and 200 day moving averages (44%) for those investors who pay closer attention to technicals, and provided a list of companies in most of the major economic sectors that we find attractive and some that we find unattractive based on AFG’s investment criteria, which focuses more on valuation attractiveness and expected corporate performance.

However, if you do look at momentum, a variable we would suggest concentrating on is economic momentum. AFG’s economic momentum coupled with valuation give you a tremendous advantage in outperforming!

Sectors without adequate representation were excluded (Financials, Basic Material, Transportation)

Yesterday we provided a list of 10 companies and asked our readers to comment on which they liked and which they did not to see how good VE.com readers are at separating the wheat from the chaff. Listed below are the same 10 companies listed in order of attractiveness (most attractive at the top, least attractive at the bottom) to give our readers an idea of our take on these companies to compare with your own thoughts.

source: www.economicmargin.com

Investment Insights from your peers, Professional Investors - The Applied Finance Group would like to invite professional investors to join AFG’s Market Forecast Project so you can better understand what your peers currently think about the market and cultivate the “wisdom of Crowds” into actionable investment ideas and themes. 
Click here to learn more

We think 5 of the companies listed below currently look attractive as potential investment opportunities and 5 that look like potential torpedoes. Share your thoughts on which of these companies you like and those that you don't. We will share our thoughts on all 10 tomorrow.

What are your thoughts on these 10 companies?

source: www.economicmargin.com

Investment Insights from your peers, Professional Investors - The Applied Finance Group would like to invite professional investors to join AFG’s Market Forecast Project so you can better understand what your peers currently think about the market and cultivate the “wisdom of Crowds” into actionable investment ideas and themes. 
Click here to learn more

When analysts and market pundits come on tv to talk about stock picks, they usually talk about the "P/E" ratio (Price to Earnings) being attractive.  However if you're investing in stocks and you only look at the "P/E" ratio, you might be walking into a "Value Trap".  Investors ignore half the valuation picture when investors only concentrate on P/E as investors also need to consider the growth potential of the company and what investments are needed to get the earnings.  The Applied Finance Group (AFG) has developed a process that incorporates these factors easily into the valuation framework.  Using AFG’s Valuation Metric, we have compiled a list of 20 companies with low P/E, 10 of which we consider attractive investments, and 10 of which we consider Value Traps.

By using AFG's Economic Margin framework instead of earnings alone, investors capture the true net cash flow the entire firm is generating. It is not uncommon for companies to grow P/E while having declining EM’s. This occurs when the cost for the investment required to yield the increasing P/E is more than the cash flow generated from the investment. By analyzing a company’s EMs through time, investors gain a more accurate account of levels and changes in a company’s current profitability and value.

If earnings are a true proxy for performance, there should be a correlation between a company growing earnings and its price to earnings ratio. As a surprise to many investors, there is actually little to no correlation between earnings growth and price to earnings ratios (see chart below).
 

P/E is determined by taking a stock’s price and dividing it by the last four quarter’s worth of earnings. P/E alone should not be used to value companies. P/E does not look at a company’s balance sheet thus we do not know what the costs of generating those earnings. While the P/E is determined by looking at a company’s past performance, EM bases a company’s value off its future projections. By using EM, an investor can know how their stocks are likely to perform, allowing them to clearly evaluate where to invest.

Successful companies measure results, make decisions and set strategy with the goal of creating value. A company’s performance measures must serve as a proxy for its market value creation. While important, S-T Earnings alone are a poor indicator of a company’s value, due to what they do not measure.
 

Economic Margin is a more complete performance measure for companies to use to guide performance and motivate employees. Executives consider Cash Flow, Investment, Competition & Risk when setting strategy. The above charts show that investors do the same.

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.

Investment Insights from your peers, Professional Investors - The Applied Finance Group would like to invite professional investors to join AFG’s Market Forecast Project so you can better understand what your peers currently think about the market and cultivate the “wisdom of Crowds” into actionable investment ideas and themes. 
Click here to learn more

In our March Monthly Market Review we released a series of graphs representing the valuation attractiveness of each sector relative to its historical norms and to the entire AFG universe. Below is a graph representing the Capital Goods sector which is attractively priced when you compare against its historical trading ranges (red line) and when comparing against the overall AFG Universe (represented by the value of 1). Only in 1998 has the sector looked more attractive since our valuation tracking started in 1996. Listed are 10 companies in the Capital Goods sector that meet AFG’s Buy Criteria and look attractive from a valuation standpoint. Also listed below the graphs are an explanation of AFG’s Buy Criteria and AFG’s Percent to Target Charts.

Capital Goods Relative Valuation Chart

10 Capital Goods Companies (S&P 500) With Attractive Valuations

Percent to Target Chart -This graph shows the Percent to Target Current (Valuation Attractiveness) for a universe relative to the overall market. Values greater than 1 indicate the universe is more undervalued than the market, while values less than 1 indicate the opposite. The red line identifies the historical median value to provide a basis to understand valuation levels relative to historic norms. This example illustrates that the median Large Cap company is undervalued relative to the market currently and has been trading at a discount to its historic relative valuation, indicating a potentially attractive opportunity.

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 its peers.

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

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Fidelity’s Low Priced Stock Fund, which launched in 1989 (18 Billion AUM) and is managed by Joel Tillinghast, follows a simple strategy… Only invest in stocks with a share price under $35. This strategy first started with Tillinghast only investing in stocks below $10 a share, but later he moved the limit up to $35 a share. He argues that share price alone is not important but that the small-cap universe contains the most frequently mispriced stocks and the least amount of analyst coverage.

Although his fund at best has been a market performer as of late, Tillinghast had taken advantage of such mispricing’s during the last 15 years, averaging an 11% annual return compared to the 6% return earned by the S&P 500 over the same period. The fund had been closed to investors since 2003, but was recently reopened in December. Fidelity says they reopened the fund to get more cash inflow to be able to take advantage of all of the investment opportunities they see in the market.

Below is a list of the top holdings in Fidelity’s Low Priced Stock Fund as well as stocks that AFG believes are attractively priced in three price brackets: under $10, $10 to $20, and $20 to $35. Compare the implied sales growth priced-in to justify the current trading price (VE Sales Growth) vs. what the company has delivered in sales growth the past 5 years (5 Year Median Sales Growth) to see if the expectations are realistic for the company to achieve. The more realistic the expectations are, compared to what has been delivered, the more likely the firm will be to out-perform.