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In our July 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 AFG Technology 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). Listed are 5 attractive and 5 unattractive companies in the AFG Technology sector that are within the S&P 500. Also listed below the graph is an explanation of AFG’s Relative Valuation Chart.

A few days ago when BHP Billiton (NYSE:BHP) offered to buy Potash Corp (NYSE:POT) for $130 a share or $39 billion in total, Potash management rejected the offer right away claiming the purchase price is “grossly inadequate”. BHP management refused to raise its bid, but POT shares still rose above $130 to trade around $143. As explained in our post Potash Should Take BHP Money and Run, the $143 trading price implies 60% annual sales growth for POT for the next 5 years assuming its 5 year median EBITDA margin. A very lofty expectation! We hope Potash management works with BHP to settle the deal and don’t let the opportunity slip. Otherwise, they are doing a big disservice to shareholders and POT shares will face a free fall should the deal fail to go through. Today, news broke Intel Corp (NASDAQ:INTC) has offered to acquire McAfee Inc. (MFE) for $7.7 billion or $48 a share. So far, we haven’t heard any objection from McAfee management! To deserve such an offer, McAfee will need to deliver an average sales growth of 15% and EBITDA margin of 21% for each of the next five years. To provide some perspective, in the past five years, McAfee’s sales have grown at an annualized 16%, including multiple acquisitions. Its EBITDA margins have consistently been below 21% during the past decade, except in 2005 and 2009. While it is not entirely impossible, McAfee will likely have trouble delivering double digit growth for the next 5 consecutive years, considering the US economy is on the brink of a double dip, and the overall developed economy is expected to grow just 2.3-2.7% in each of the next 2 years, according to the World Bank. McAfee share holders are being offered a good price and it is wise of McAfee management to cooperate and make sure this deal complete without any unnecessary drama.

The flowchart below outlines The Applied Finance Group’s custom screening process which takes into account several factors to screen on as well as provides step by step process to end up with the highest quality investment ideas. In Step 1 of AFG’s custom screening process we identified companies that were trading at a discount to their intrinsic value as AFG’s valuation process is a key component in the screening process. Today we will combine the criteria of looking for cheap companies with companies expected to improve their economic profitability (Economic Margins) as well. Economic Margins are highly correlated with market values and can provide investors an edge in their stock selection process if they have an understanding of a company’s true economic profitability. Our daily examples will show that an increase in margins typically leads to market out performance, where a decline in margins leads to market under performance.

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!)

Ticker  Name Sector AFG Recommendation (NYSE:PFE)  PFIZER INC Health Attractive (NYSE:S)  SPRINT NEXTEL CORP Technology Attractive (NYSE:VZ) VERIZON COMMUNICATIONS Technology Attractive (NASDAQ:ORCL)  ORACLE CORP Technology Attractive (NASDAQ:DTV) DIRECTV GROUP INC (THE) Consumer Services Attractive (NYSE:Q)  QWEST CMMNCTNS INTL INC Technology Attractive (NYSE:DYN)  DYNEGY INC A Energy and Extraction Attractive (NASDAQ:EBAY) EBAY INC Consumer Services Attractive (NYSE:CHK) CHESAPEAKE ENERGY CORP Energy and Extraction Attractive (NYSE:WMT) WAL-MART STORES INC Consumer Services Attractive (NYSE:CVS) CVS CAREMARK CORP Consumer Services Attractive (NASDAQ:MSFT) MICROSOFT CORP Technology Attractive (NASDAQ:CSCO) CISCO SYSTEMS INC Technology Attractive (NYSE:BSX)  BOSTON SCIENTIFIC CORP Health Neutral (NYSE:TXN) TEXAS INSTRUMENTS INC Technology Neutral (NYSE:LOW) LOWE'S COMPANIES INC Consumer Services Neutral (NASDAQ:CMCSA) COMCAST CORP CL A Consumer Services Neutral (NYSE:MU)  MICRON TECHNOLOGY INC Technology Neutral (NYSE:XRX) XEROX CORP Consumer Durable Neutral (NASDAQ:DELL) DELL INC Technology Neutral (NYSE:EMC) EMC CORP Technology Neutral (NYSE:XOM) EXXON MOBIL CORP Energy and Extraction Neutral (NASDAQ:INTC) INTEL CORP Technology Neutral (NASDAQ:NVDA) NVIDIA CORP Technology Neutral (NASDAQ:YHOO) YAHOO! INC Miscellaneous Neutral (NYSE:MOT)  MOTOROLA INC Technology Neutral (NASDAQ:NWSA)  NEWS CORP A Consumer Services Neutral (NYSE:AMD)  ADVANCED MICRO DEVICES Technology Neutral (NASDAQ:AAPL) APPLE INC Technology Neutral (NYSE:MO) ALTRIA GROUP INC Consumer Non Durable Neutral (NASDAQ:QCOM) QUALCOMM INC Technology Neutral (NASDAQ:AMAT) APPLIED MATERIALS INC Technology Unattractive (NYSE:AA) ALCOA INC Basic Material Unattractive (NYSE:T) AT&T INC Technology Unattractive (NYSE:HAL) HALLIBURTON CO Capital Goods Unattractive

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

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.

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.

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