MMR

Many of the institutional clients of The Applied Finance Group, Ltd. (AFG) tend to focus on large cap stocks and benchmark themselves against the S&P 500 Index, which is why many of the buy ideas from ValueExpectations.com usually come from the large cap index. Earlier in the week we highlighted companies from our buy/sell list both from large and small cap, as well as from growth and value style universes. We thought it would be a good follow up for some of the investors we work with who focus on small and mid cap stocks, to provide a more thorough list of companies from the Russell 2000 Index.

Below is a summary of 20 companies to watch from the Russell 2000 Index. The table highlights the 2 companies from each sector (ex. Financials) that have the most attractive Value Score (above 80) and are currently rated Neutral or higher by AFG’s buy/sell criteria. Factors used to derive an AFG recommendation include: Expected change in Economic Margins, Intrinsic Value, and Management Quality. Many classify stocks with market capitalization under $250 million as micro caps, therefore only those companies within the index that met that market cap minimum were considered for the list.

Russell 2000 - Stocks to Watch (above $250 million, ex financials)

What do we use to measure corporate performance and calculate an intrinsic value:
AFG’s 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 its cost of capital. Our Economic Margin Framework encompasses a valuation system that explicitly addresses the four main value drivers of enterprise value: profitability, competition, growth, and cost of capital.
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).
Management Quality – Assesses management’s ability to make wealth creating decisions.
AFG's Value Universe - Companies in the AFG universe, which have MV/IC at the bottom 50% of the universe and have EPS estimates.

Stocks that have dropped significantly in price and are trading at all time lows provide investors attractive entry points, but some of those stocks could be deceptively “cheap”. Being able to discriminate between the two is a valuable skill for every portfolio manager and stock picker.

 In order to identify a good investment opportunity, AFG starts with assessing corporate performance by evaluating the ability for firms to generate Economic Margins above their sector median. Companies with expected improvement in their EMs tend to outperform companies with deteriorating EMs. In addition to corporate performance, AFG evaluates the valuation attractiveness and embedded expectations priced into the market through the Value Expectations interface.

The table below shows the 30 companies within the Russell 2000 Index with the greatest decline from their 52-week high trading price (as of April 30, 2009), and their attractiveness based on the ranked score of the expected change in economic profitability. In addition, we have pulled AFG’s Value Score, a measure of valuation attractiveness, and VE Sales Growth numbers, which show embedded market expectations. The companies within the Financial sector have moved for reasons other than valuation, and will not be evaluated from a valuation perspective here.

Russell 2000 - 30 Companies With The Biggest Drop From 52 Week High (ex. Financials)

*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.