PXD

A focus list of buys and sells for our readers to use as a starting point when looking to make changes to portfolio. This list contains attractive and unattractive stocks from every major sector excluding financials. AFG's buy and sell lists have proven through time to provide a significant spread between the buys and sells helping you to identify winners and avoid potential torpedoes.

Using The Applied Finance Group's (AFG's) Value Expectations interface we have provided an analysis of the expectations embedded in the stock prices of some of the top performers in the S&P 500 year to date (excluding financials) to see which companies have the lowest expectations for sales growth (VE Sales Growth) relative to what the company has been able to deliver historically (5 Year Median Sales Growth).

AFG’s Value Expectations interface provides clients a platform to better understand economic profitability, and at the same time understand the performance a company must deliver to justify its current stock price. By understanding the embedded expectations a company must deliver to justify their current trading price, clients can develop a “hurdle rate” to quickly determine if the company’s expectations are rich or low. Take, for example, the typical company during the tech bubble: the expectations that were priced into the average tech stock far exceeded what it could realistically deliver. For this reason, AFG identified the technology sector as overvalued, as well as potential torpedoes such as Cisco, whose expectations were unrealistically high.

By gaining a better understanding of the embedded expectations built in to security prices, relative to what a company has delivered historically, can provide insight into the Sales Growth, EBITDA Margin, and Asset Turnover a company must deliver in the future to justify its current trading price. In many circumstances, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued.

The top performers of the S&P 500 listed below are ranked based on valuation attractiveness using The Applied Finance Group’s valuation model. You would like to look for companies with attractive valuations and modest expectations for revenue growth relative to what the company has been able to achieve over the past five years when looking for potential investment opportunities as these types of companies have proven through time to outperform firms with the opposite characteristics.

If you would like to view some of the favorite long and short investment ideas provided by professional investors click here to view the results for AFG's Market Forecast Project.

Sales Growth Expectations of S&P 500 Top Performers of 2009

Ticker Name Sector Valuation Attractiveness 5 Year Median Sales Growth VE Sales Growth (NYSE:WDC)  WESTERN DIGITAL CORP Technology Attractive 19.43% 12.00% (NYSE:FCX) FREEPORT-MCMORAN C & G Basic Material Attractive 5.06% -6.13% (NASDAQ:CTSH) COGNIZANT TECH SOL CP A Technology Attractive 50.98% 18.34% (NYSE:FTI) FMC TECHNOLOGIES INC Capital Goods Attractive 17.48% 11.56% (NYSE:PXD)  PIONEER NATURAL RESCS CO Energy and Extraction Attractive 20.90% -0.39% (NYSE:IP) INTERNATIONAL PAPER CO Basic Material Fair -5.68% 14.49% (NYSE:WYN) WYNDHAM WORLDWIDE CORP Consumer Services Fair 13.48% 8.58% (NYSE:MWV) MEADWESTVACO CORP Basic Material Fair 5.76% 47.66% (NYSE:AMD)  ADVANCED MICRO DEVICES Technology Fair 6.44% 7.36% (NASDAQ:AAPL)  APPLE INC Technology Fair 35.30% 20.62% (NYSE:MEE)  MASSEY ENERGY CO Energy and Extraction Unattractive 15.08% 35.02% (NYSE:JWN)  NORDSTROM INC Consumer Services Unattractive 8.29% 16.02% (NASDAQ:JAVA)  SUN MICROSYSTEMS INC Technology Unattractive 0.05% 26.04% (NASDAQ:SBUX) STARBUCKS CORP Consumer Services Unattractive 20.86% 14.43% (NYSE:HAR)  HARMAN INTERNAT IND INC Consumer Durable Unattractive 9.34% 4.45% (NASDAQ:WFMI)  WHOLE FOODS MARKET INC Consumer Services Unattractive 20.66% 12.62% (NASDAQ:NTAP)  NETAPP INC Technology Unattractive 29.31% 28.26% (NASDAQ:AMZN)  AMAZON.COM INC Consumer Services Unattractive 29.19% 30.00% (NYSE:ODP)  OFFICE DEPOT INC Consumer Services Unattractive 5.13% 1.24% (NASDAQ:ISRG) INTUITIVE SURGICAL INC Health Unattractive 61.20% 37.96%

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.

 

To stay updated on how other professional investor's currently view the market join our Market Forecast Project survey and be among the first to receive the results.

Listed below are the companies in the Energy & Extraction sector within the S&P 500 Index, ranked in order of valuation attractiveness. Currently, the Energy & Extraction sector has the highest median Value Score of all sectors according The Applied Finance Group’s April 2009 Monthly Market Review and looks to be trading at a significant discount relative to its historic valuation.

All Energy Companies (S&P 500) Ranked By Valuation Attractiveness

Energy Sector - Relative Valuation Chart

The graph above shows the median percentage upside for the Energy sector relative to the overall market across time. Values greater than 1 indicate the sector 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 Energy company is undervalued relative to the market currently and has been trading at a significant discount to its historic relative valuation, indicating a potentially attractive opportunity.

 

Economic Margin is a measure of economic profitability that identifies how much a company earns above or below its cost of capital. We analyzed all companies in the S&P500 Index based on their historical, current and forecasted Economic Margins to see which firms have the best average of past, present and future profitability. We identified the two most profitable and the two least profitable companies from each sector and have presented them in the table below. As a base of reference, the average firm in corporate America earns a 0 (zero) Economic Margin, or is a “break-even business”. Our research has shown that companies with consistently positive EMs that are also expected to increase their EMs in the future tend to outperfom firms with negative or declining EMs.
<!--[if gte mso 10]> Economic Margin is a corporate performance measure, which helps us identify well managed, wealth creating companies. Although not included in this post, we want to remind you that it is also important to understand the attractiveness of corporations' valuations to make sure we invest in great companies at great prices. (Here is an article by ValueExpectations.com explaining Applied Finance Group’s basic valuation concepts).

Note: Only companies in the S&P 500 were included.

 

S&P 500 Companies With The Best/Worst Average Profitability (Economic Margin)

 

Economic Margin (EM) Defined: A measure of corporate performance that captures off balance sheet items, by looking at how much a company is earning above or below their cost of capital. EM is expressed in a % or margin. The Economic Margin Framework™ is more than just a performance metric as it encompasses a valuation system that explicitly addresses the four main drivers of enterprise value: profitability, competition, growth and cost of capital. more EM details (PDF)

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.