NFLX

Barron's is a well-respected, widely-publicized weekly newspaper that covers U.S. financial information, market developments, and relevant statistics. Each issue provides a wrap-up of the previous week's market activity and news reports, as well as an informative outlook on the week to come. An interesting piece within Barron’s that garners special attention each week is their interviews of well-known fund managers (who often manage over 1 Billion in A.U.M.), which gives their best stock picks. According to a 1994 study by Gary Banesh and Jeffrey Clark from The Journal of Financial and Strategic Decisions (The Value of Indirect Investment Advice: Stock Recommendations in Barron’s), stock picks from Barron’s weekly Money Manger Interview outperform the market. The success of the picks from Barron’s is likely due to the fact that each fund manager provides one pick, which is usually a holding in their fund, and the success of that pick could bring their fund new investors. Therefore, there is plenty of incentive for these managers to get their best picks in front of the public’s eyes via Barron’s.

The great Austrian School economist Ludwig Von Mises once wrote that the entrepreneur who fails to use his capital to the "best possible satisfaction of consumers" is "relegated to a place in which his ineptitude no longer hurts people's well-being." Von Mises meant that successful businesses are successful because they fill an unmet need. If they're unsuccessful, it is often because they have failed the consumer. In that case bankruptcy is an economic good for relieving those the market has left for dead of any further capital to destroy. The demise of Blockbuster Video (NYSE:BBI) offers some lessons about Schumpeterian creative destruction, the necessary role of short-sellers in making markets transparent and the role of capital in rewarding winners and losers. Once a popular growth stock among investors, Blockbuster is now a sick company teetering on the edge of bankruptcy. While it would be foolish to cheer Blockbuster's decline, its descent speaks to the importance of allowing companies no longer fulfilling market needs to go bankrupt.

The Russell 1000 Index has lost 44% over the past year and is down 14% year to date. Similarly, the Russell 2000 Index is down 42% for the past 12 months and lost investors 18% since the beginning of this year. With both of these indexes down substantially recently by about the same amount, are large caps more attractive than small caps?

Percent to Target Charts: This graph shows the Percent to Target Current 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.

Small Universe: Companies in the AFG universe that have a market cap less than $300 million and EPS consensus estimates are available.

This chart illustrates that the median Small Cap company is currently overvalued, relative to the market. Over the past 6 years, small Caps have been trading at a premium to their historic valuation.

 

Large Universe: Companies in the AFG universe that have a market cap greater than $2 billion and EPS consensus estimates are available.

This chart illustrates that the median Large Cap company is currently undervalued, relative to the market. Large Caps have been trading at a discount to their historic valuation, indicating a potentially attractive opportunity.

 

 

Following is a list of the biggest 10 companies (determined by market cap) in the Russell 1000 and Russell 2000. AFG’s Value Expectations interface, which solves for implied sales growth embedded in a stock price (VE Sales Growth), allows us to understand the embedded 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. An undervalued company is more likely to outperform those companies with high expectations relative to what they have delivered historically. The tables below display the implied future sales growth of these companies assuming their EBITDA margins and Asset turnovers stay at their 5-year median levels.

 

 

Conclusion:
Both the percent to target charts and VE analysis show that large caps look more attractive than small cap stocks. The large cap stocks on the list have lower expectations for implied sales growth and the overall universe is currently undervalued. 

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