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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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Earlier in the week we highlighted the most attractive style and sector universes from our Monthly Market Review. As a follow up to that article we are providing a list of the 10 most undervalued stocks in the S&P500. All companies listed met The Applied Finance Group's (AFG's) Buy screen (criteria explained below) and are in the bottom half of their sector in Market Value/Invested Capital (MV/IC) which by definition qualifies the companies as part of the AFG Value Universe.

 10 Most Undervalued Stocks In The S&P500

When identifying buy ideas AFG looks for companies with the most valuation upside compared to their sector peers, above sector median expected Economic Margin change, and a management quality score that reflects a management team following a wealth creating strategy.

A brief description of AFG'sbuy 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.

Value Universe: Companies in the AFG universe, which have MVIC at the bottom 50% of the
universe and have EPS estimates.

Market Value/Invested Capital - The firm's average total equity, debt and other obligations divided by net invested capital

*AFG’s Value Expectation allows us to understand the imbedded Sales Growth, EBITDA Margins, and Asset Turnovers 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 companies assuming their EBITDA margins and Asset turnovers stay at the 5 year median levels.

Recent Market Review:  Obama, the Budget and the “Un” Stimulus package

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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. 
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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.

Nearly all of the biggest return earning companies in the S&P 500 are firms that have been beaten up over the past few months but have bounced back to provide the biggest return in the entire index for the month of December. These firms have ended 2008 on a high note and move into 2009 with what they hope to be sustainable momentum.

The list of companies in the S&P 500 with the worst returns in December had also been trending downward for the past few months but were unable to muster a year-end turnaround as those on the other list had been able accomplish. Many of the firms on this list have something to do with oil, as their stock prices have been highly correlated with the falling price of oil.

Compare the sales growth priced-in to justify the current stock price (VE Sales Growth), to what the company has been able to deliver the past 5 years in revenue growth (5 Year Median Sales Growth), to see which companies have reasonable expectations of achieving the Sales Growth priced-in. Companies with low expectations relative to what they have been able to achieve are more likely to out-perform.

Sales Growth Expectations for the Highest Return Companies (S&P 500) - December

**denotes only 2 years historical sales growth available (2 year median used)

Sales Growth Expectations for the Lowest Return Companies (S&P 500) - December

VE Sales Growth Calculated for these firms on 12/26/08.