T

The list of most actively traded stocks in the S&P 500 seems to attract the most attention amongst the investment community and always create a good amount of “Buzz”. We decided to take the list of the most actively traded stocks over the last 50 trading days (excluding financials) and run them through The Applied Finance Group’s (AFG’s) meat grinder to see which are worthy of the hype and are attractive investment opportunities and which you should probably stay away from.

AFG uses a set of criteria in its stock selection process that has proven successful at identifying winners and losers in the market including its proprietary measure of corporate performance (Economic Margin), valuation, management quality and earnings quality among other criteria. Of the companies listed that are heavily traded, AFG believes the companies with expected improvement in Economic Margins, attractive valuations, and a wealth creating management team are the companies that will be the most likely to outperform the market and their sector peers. (register now to receive exclusive buy ideas- it's fast and free!)

The rankings above were provided using AFG’s research product AFGView.com and are ranked based on AFG’s overall investment opportunity signal, valuation signal and expected changes in Economic Margins. The companies must rank as attractive or unattractive in all 3 categories or the firm is listed as neutral.

Below is a brief description of those variables with informative links.

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.

+View our List of Value Expepectations Recommended Articles

AFG Recommendation Performance
9/1998 – 5/2009
Annualized Returns

Source: AFGView client databases from 9/1998 – 5/2009
Universe size: 4,000 to 5,500 firms

When analysts and market pundits come on tv to talk about stock picks, they usually talk about the "P/E" ratio (Price to Earnings) being attractive.  However if you're investing in stocks and you only look at the "P/E" ratio, you might be walking into a "Value Trap".  Investors ignore half the valuation picture when investors only concentrate on P/E as investors also need to consider the growth potential of the company and what investments are needed to get the earnings.  The Applied Finance Group (AFG) has developed a process that incorporates these factors easily into the valuation framework.  Using AFG’s Valuation Metric, we have compiled a list of 20 companies with low P/E, 10 of which we consider attractive investments, and 10 of which we consider Value Traps.

By using AFG's Economic Margin framework instead of earnings alone, investors capture the true net cash flow the entire firm is generating. It is not uncommon for companies to grow P/E while having declining EM’s. This occurs when the cost for the investment required to yield the increasing P/E is more than the cash flow generated from the investment. By analyzing a company’s EMs through time, investors gain a more accurate account of levels and changes in a company’s current profitability and value.

If earnings are a true proxy for performance, there should be a correlation between a company growing earnings and its price to earnings ratio. As a surprise to many investors, there is actually little to no correlation between earnings growth and price to earnings ratios (see chart below).
 

P/E is determined by taking a stock’s price and dividing it by the last four quarter’s worth of earnings. P/E alone should not be used to value companies. P/E does not look at a company’s balance sheet thus we do not know what the costs of generating those earnings. While the P/E is determined by looking at a company’s past performance, EM bases a company’s value off its future projections. By using EM, an investor can know how their stocks are likely to perform, allowing them to clearly evaluate where to invest.

Successful companies measure results, make decisions and set strategy with the goal of creating value. A company’s performance measures must serve as a proxy for its market value creation. While important, S-T Earnings alone are a poor indicator of a company’s value, due to what they do not measure.
 

Economic Margin is a more complete performance measure for companies to use to guide performance and motivate employees. Executives consider Cash Flow, Investment, Competition & Risk when setting strategy. The above charts show that investors do the same.

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.

Investment Insights from your peers, Professional Investors - 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. 
Click here to learn more

AT&T and Verizon are the clear front-runners in the wireline/wireless industry. These telecom giants within the S&P 500 currently maintain market caps of nearly $150 billion and $90 billion, respectively, with Sprint coming in at a distant third, with a market cap of $12 billion. This begs the question: which of the two is better positioned for the future? Jake Kimble from Bullish Bankers, recently wrote an informative article on the two companies. From a qualitative standpoint, AT&T seems to have the stronger 3G network, and that is strongly complimented by the most formidable smart phone on the market, the iPhone, which is exclusively contracted through the company. Verizon’s 3G network is decent, and is supported by a variety of phones including several models of the Blackberry, which has also been a recent trend. Going forward though, VZ seems to be putting itself in a much better position than its competitor. The company continues to build out its FiOS fiber optic network. FiOS is a fiber-to-the-premises network (FTTP) supported by lightning fast fiber optics, which are considered to be a huge upgrade from the traditional coaxial cables currently in use, and should be the way of the future. AT&T’s fiber-to-the-node (FTTN) network only places its fiber optic network in between communities, in an effort to save costs, and runs copper coaxial cables from the outer premises to each individual house. This shortcut limits the speed of the data carried across the line. Accordingly, VZ is recently adding more FiOS customers per quarter than AT&T’s U-Verse, despite the fact that it currently has less availability. Verizon continues to build this network out and is finding cheaper ways to do so as it goes. As bandwidth continues to grow and consumers increasingly demand higher quality data and video, VZ’s investment should continue paying off, especially with an economic recovery. Furthermore, VZ has also taken a forward-looking perspective on the wireless front, as it continues to develop its 4G network. This network will handle more wireless services and with better speed and quality than 3G. VZ plans its commercial launch of its 4G network in 2010 in 30 metropolitan areas, whereas AT&T is not looking to deploy its 4G network until 2012.

So while AT&T seems to have a clear competitive advantage over VZ in the current wireless market, the tide may begin to turn in the near future as the landscape and capabilities in the telecom sector continue to change and advance. To add further perspective, ValueExpectations.com decided to analyze both companies from a valuation standpoint using AFG’s valuation model (Value Score). Using this analysis, Verizon currently looks to be an attractive play, while AT&T looks overpriced.

Verizon Vs. AT&T

Applied Finance Group’s (AFG’s) Value Score defined - A score which represents the ranked percent to target (deviation between stock’s current trading price and AFG’s current default target price) or attractiveness (upside) relative to the universe. A Value Score of 100 is the most undervalued and 0 is the most overvalued company in the universe.

If you are a professional investor and would like to learn more about AFG's valuation techniques or how our analyst's model out companies, sign up for a free trial to AFG's research and suite of investment tools.

Fortune magazine recently put out an article listing the most admired companies in the world.  We took the top 50 firms (excluding Financials, and companies not traded in the US) on their list and put them through Applied Finance Group's quantitative recommendation framework.  Just because these firms are among the most admired companies in the world does not qualify them as the most attractive investment. Being among the most admired is an honor and means you must be doing something right, but might not necessarily mean the share price is currently attractive. 

The following articles which we have posted in the past on ValueExpectations.com will give you a better understanding of what it takes for management to create wealth, understand Management Quality, and see how EPS alone falls short in estimating a company’s value. There are two main characteristics a company must have in order to be a good investment opportunity: (1) the company needs to be a strong economic performer, (2) the company should be attractively priced.   Many people admired the DeLorean, but it was neither a good performing car nor a good priced car. Below we reveal a few "DeLoreans" after looking under the hood.

Top 50 Most Admired Companies According to Fortune

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. 

This data is a sample of our Market Review.  Register to view Complete PDF... IT's Fast and FREE

If you are a registered user, click here to access complete PDF of our Market Review

According to Forbes.com, Cramer and a few other financial blog-sites the following qualities are usually found in stocks that do well in economic downturns of extended time periods.

• Consumer necessities
• Ability to pay a dividend
• Ability to add employees as other firms cut back
• Productivity increases as market goes down
• Healthcare stocks
• Legacy Companies – high quality company with long business history
• Involved in Military
• Oil industry
• Infrastructure
• Companies that sell used goods
• Generic products
• Overseas exposure

The following companies all have one or more of the above qualities to help them survive and perform well in an economic downturn. This table provides the implied 5 year sales growth priced-in to the stock to justify its current price along with the 5 year median achieved sales growth. Compare the revenue growth priced-in to what the company has been able to deliver in the past 5 years to see if the expectations are reasonable enough for the company to meet. Companies with reasonable expectations compared to what they have achieved are the most likely companies on the list to out-perform.

Stocks with Recession Resistant Qualities & Sales Growth Expectations

When measuring the implied sales growth expectations priced-in to the eight biggest market cap companies in the Russell 2000 and the S&P 500, the larger cap S&P companies have lower expectations priced-in than the Russell 2000 companies. The median sales growth expectations, for the Russell 2000 is 11.76% compared to the 0.74% median priced-in to the S&P 500 companies. 

Given the bigger presence and management quality of these eight companies in the S&P 500,  we see them as a better investment oportunity based on the low expectations the market has placed into their current stock prices.

Top 8 Market Cap Companies and Sales Growth Expectations

Russell 2000

S&P 500

16 Potential Torpedoes - That Could Be Lurking In Your Portfolio

AFG recommendations are ranked and have consistently identified winners and losers, therefore, this list of potential torpedoes should be given a second look if you own them or are considering adding them to your portfolio as they have characteristics that AFG has proven to be more likely to under-perform.