PDE

Below is a list of the 12 most undervalued stocks in the Russell 1000. 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. 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. Also shown in the table is each companies implied sales growth expectations along with their historical sales growth. All 12 of these companies have very reasonable expectations for growing their sales relative to what they have been able to deliver historically. Companies with reasonable expectations embedded in their current price have proven to be more likely to out-perform than companies with high expectations.

12 Most Undervalued - Russell 1000 (excludes financials)

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.

There are many ways professional equity investors use to narrow their list of investment constituents; by size, value, growth, sales growth, earnings growth, etc. When ValueExpectations.com looks for investment opportunities or to avoid potential torpedoes, we start with a focus on accessing Valuation, Corporate Performance (Economic Margin), and Management Quality of companies. These variables have proven very successful in finding winners and avoiding losers in different market caps, different styles, and different economic sectors, helping professional investors make sound stock selections in the past 13 years. These and many other proprietary variables can be screened on Applied Finance Group’s (AFG’s) institutional product www.AFGView.com.

Enjoying an accomplished methodology and process of selecting stocks doesn’t prevent us from learning how other people are identifying their fishing pool. We recently came across SA Editor Eli Hoffman's recommended list of stocks based on a set of variables that , he believes benefit both growth and value investors as these companies contain characteristics both investors will find attractive. These stocks were identified by what the author calls “a powerful screen and helps find strong companies at great values”.

Eli Hoffman's screen includes the following criteria:

• Only companies identified as Buys by Zack’s
• Companies with the highest 5 year historical earnings growth rates (top 20% all Zack’s Buy Rec.)
• Lowest P/E ratio (bottom 20% all Zack’s Buy Rec.)
• Trading over $5 a share
• 10 day avg. share volume of 50,000 shares or more

As the AFG methodology has also proven effective in identifying attractive stocks regardless of their Growth or Value characteristics, we thought it would be interesting to check the valuation attractiveness of Mr Hoffman’s stocks via AFG’s Value Expectation application. 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 following table displays the implied future sales growth of Mr Hoffman’s companies assuming their EBITDA margins and Asset turnovers stay at the 5 year median levels.

Companies recommended by Mr Hoffman appear to have pessimistic future sales growth implied by their current stock prices, when compared to their historical sales growth, and appear to be undervalued from AFG’s valuation perspective. Before making a wise investment decision, however, we also need to understand a company’s corporate performance (Economic Margin), management quality, competitive advantages and valuation attractiveness relative to its industry and sector peers. AFG’s institutional product helps investors to gain considerable insight regarding those aspects through its proprietary framework and we will provide a detailed tutorial of this process next week. 

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