TMO

A list of attractive stocks from within the Health sector that meet AFG’s definition of attractive based on Valuation, Corporate Performance, Management Quality and other key criteria AFG uses to identify the stocks that are most likely to outperform from within each sector. The Health sector has consistently ranked as the 2nd best sector to invest in (next to Technology) over the next year according to participants of The Market Forecast Project, a monthly survey of professional money managers.

The Applied Finance Group (AFG) has a disciplined approach for identifying companies that are expected to outperform and underperform the market by using proprietary metrics and measurements that have been tested and proven through time. Because AFG’s research is fundamentally derived, AFG’s quantitative analysis spans across growth and value stocks, all sectors, industries, and market caps with over 20,000 covered securities globally. Using AFG’s proprietary criteria, AFG publishes a monthly buy/sell list to provide clients with a refined focused list as a starting point for potential investments. AFG clients can then use Value Expectations to further analyze the expectations embedded in a security’s price and to build out their own model to refine an intrinsic value of a company based on their own expectations.

When searching for Large-Cap ideas, AFG’s Buy/Sell list is a good starting place as it has proven to create a significant spread in performance between companies that come up on AFG’s buy list and those on the sell list. Further focusing on companies based on AFG’s proprietary screening criteria (Economic Margin, valuation, quality of earnings, and management’s ability to create shareholder wealth) will save investors time in their research process.  The result is a target group of stocks that can help you outperform as well as identify potential torpedoes to avoid in your portfolios.

Below is a list of attractive and unattractive companies in the S&P 500 from each major sector (as defined by AFG).  It serves as a focus list of companies for investors to begin with as they meet AFG’s criteria.  They are more likely to outperform their sector peers and the S&P 500, the benchmark that AFG’s clients most often compare themselves with.

AFG Investment Opportunity Rank within Sector Ticker Name Sector Valuation Signal EM Change Signal Attractive S&P 500 companies from each AFG Sector (NYSE: ARG) AIRGAS INC Basic Material Attractive Attractive Positive (NYSE: SEE) SEALED AIR CORP Basic Material Attractive Attractive Positive (NYSE: WAT) WATERS CORP Capital Goods Attractive Attractive Positive (NYSE: DO) DIAMOND OFFSHRE DRILLING Capital Goods Attractive Attractive Positive (NYSE: HAS) HASBRO INC Consumer Durable Attractive Attractive Positive (NYSE: CL) COLGATE-PALMOLIVE CO Consumer Non Durable Attractive Attractive Positive (NYSE: TAP) MOLSON COORS BREWING CLB Consumer Non Durable Attractive Attractive Positive (NYSE: MCD) MCDONALD'S CORP Consumer Services Attractive Attractive Positive (NYSE: MCD) CVS CAREMARK CORP Consumer Services Attractive Attractive Positive (NYSE: NEM) NEWMONT MINING CORP Energy and Extraction Attractive Attractive Positive (NASDAQ:CEPH)  CEPHALON INC Health Attractive Attractive Positive (NYSE:TMO)  THERMO FISHER SCIENTIFIC Health Attractive Attractive Positive (NYSE:S)  SPRINT NEXTEL CORP Technology Attractive Attractive Positive (NASDAQ:SYMC)  SYMANTEC CORP Technology Attractive Attractive Positive (NYSE:PEG)  PUBLIC SVC ENTPRS GROUP Utilities Attractive Attractive Positive (NYSE:D) DOMINION RESOURCES VA Utilities Attractive Attractive Positive Unattractive S&P 500 companies from each AFG Sector (NYSE:PH) PARKER HANNIFIN CORP Basic Material Unattractive Unattractive Negative (NYSE:X) UNITED STATES STEEL CORP Basic Material Unattractive Unattractive Negative (NYSE:ETN)  EATON CORP Capital Goods Unattractive Unattractive Negative (NYSE:SWK)  STANLEY WORKS THE Capital Goods Unattractive Unattractive Negative (NYSE:IGT) INTERNAT GAME TECHNOLOGY Consumer Durable Unattractive Unattractive Negative (NYSE:FO) FORTUNE BRANDS INC Consumer Durable Unattractive Unattractive Negative (NYSE:RL)  POLO RALPH LAUREN CORP Consumer Non Durable Unattractive Unattractive Negative (NYSE:TSN)  TYSON FOODS INC Consumer Non Durable Unattractive Unattractive Negative (NYSE:MAR)  MARRIOTT INTERNAT INC A Consumer Services Unattractive Unattractive Negative (NYSE:MWW)  MONSTER WORLDWIDE INC Consumer Services Unattractive Unattractive Negative (NYSE:BTU) PEABODY ENERGY CORP Energy and Extraction Unattractive Unattractive Negative (NYSE:EOG)  EOG RESOURCES INC Energy and Extraction Unattractive Unattractive Negative (NASDAQ:SIAL) SIGMA-ALDRICH CORP Health Unattractive Unattractive Negative (NASDAQ:ISRG)  INTUITIVE SURGICAL INC Health Unattractive Unattractive Negative (NYSE:MU)  MICRON TECHNOLOGY INC Technology Unattractive Unattractive Negative (NASDAQ:CIEN)  CIENA CORP Technology Unattractive Unattractive Negative (NYSE:EQT)  EQT CORP Utilities Unattractive Unattractive Negative (NYSE:NU)  NORTHEAST UTILITIES Utilities Unattractive Unattractive Negative

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.

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In recent weeks we have written several blogs (S&P 500 sector stock watch, Attractive stocks under $35, with potential investment opportunities, Solid S&P Value Companies, Cheapest Stocks In the S&P 500), discussing investment opportunities within the S&P 500. These stocks ideas all had favorable scores under The Applied Finance Group's (AFG’s) investment criteria, which includes economic performance, valuation, earnings quality and management’s ability to create shareholder wealth, among other criteria.

Another way that AFG identifies potentially attractive investments is through the use of its Value Expectations interface, which helps investors get a better understanding of the expectations embedded into stock prices. This interface allows us to understand the Sales Growth, EBITDA Margin, and Asset Turnover 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 below displays the implied future Sales Growth (“Priced-in Sales Growth) of the companies we have recently recommended in our recent blogs, assuming their EBITDA Margins and Asset Turnovers stay at 5-year median levels.

Company Descriptors Sales Growth   Ebitda   Asset Turnover Exchange/Ticker Name Sector "Priced-in" Sales Growth 5 Year Median LFY   5 Year Median LFY   5 Year Median LFY (NYSE:ABT) ABBOTT LABORATORIES Health 6.32% 13.51% 13.94%   25.34% 24.83%   0.69 0.70 (NYSE:AEP)  AMERICAN ELECTRIC POWER Utilities 9.53% 4.22% 7.92%   27.14% 28.82%   0.33 0.32 (NYSE:AES)  AES CORP THE Utilities -4.73% 12.73% 18.27%   34.66% 29.23%   0.39 0.46 (NASDAQ:APOL) APOLLO GROUP INC CL A Miscellaneous -2.48% 15.31% 15.31%   28.46% 25.59%   1.71 1.69 (NYSE:AZO) AUTOZONE INC Consumer Services -8.92% 3.72% 5.72%   19.59% 19.72%   1.33 1.24 (NYSE:BIG)  BIG LOTS INC Consumer Services 15.47% 1.25% -0.24%   5.44% 6.86%   2.74 3.24 (NYSE:BMY)  BRISTOL-MYERS SQUIBB CO Health -1.23% -0.89% 6.46%   24.98% 22.84%   0.70 0.70 (NYSE:BSX)  BOSTON SCIENTIFIC CORP Health 5.14% 11.72% -3.67%   28.70% 27.68%   0.45 0.30 (NYSE:CAG)  CONAGRA FOODS Consumer Non Durable 23.23% 0.31% 9.70%   11.31% 10.74%   1.02 1.15 (NASDAQ:CEPH)  CEPHALON INC Health -5.73% 19.35% 11.40%   26.65% 26.37%   0.47 0.62 (NYSE:DNB) DUN & BRADSTREET CORP Consumer Services -18.53% 4.43% 7.95%   30.41% 32.09%   0.93 1.09 (NYSE:DPS)  DR PEPPER SNAPPLE GRP Consumer Non Durable 15.11% 10.36% -0.66%   20.60% 20.60%   0.55 0.66 (NYSE:DRI)  DARDEN RESTAURANTS Consumer Services -1.78% 8.38% 8.92%   13.02% 12.80%   1.80 1.44 (NASDAQ:ERTS) ELECTRONIC ARTS INC Technology 2.34% 5.81% 14.93%   10.99% -2.24%   0.69 0.90 (NYSE:FIS) FIDELITY NATIONAL INFO Consumer Services -7.42% 7.47% -27.57%   23.50% 26.76%   0.83 0.46 (NASDAQ:FISV)  FISERV INC Miscellaneous 14.41% 11.94% 20.83%   22.99% 23.53%   0.48 0.51 (NYSE:HAS)  HASBRO INC Consumer Durable 2.47% 3.01% 4.79%   16.31% 17.62%   1.00 1.27 (NYSE:HRS)  HARRIS CORP Technology -1.48% 19.14% -5.76%   15.24% 15.96%   1.13 1.12 (NYSE:KR)  KROGER CO THE Consumer Services 4.51% 7.30% 8.21%   5.31% 5.21%   3.04 3.27 (NYSE:LO)  LORILLARD INC Consumer Non Durable -5.09% 5.62% 5.92%   33.08% 32.55%   1.44 1.81 (NYSE:NOC)  NORTHROP GRUMMAN CORP Capital Goods 1.10% 5.84% 5.84%   9.99% 11.63%   0.92 1.12 (NYSE:PEG)  PUBLIC SVC ENTPRS GROUP Utilities 7.72% 3.65% 3.65%   24.57% 30.23%   0.42 0.46 (NYSE:PFE)  PFIZER INC Health -4.75% -0.25% -0.25%   40.22% 32.09%   0.42 0.43 (NYSE:PM) PHILIP MORRIS INTL INC Consumer Non Durable 18.90% -10.87% -53.35%   18.26% 17.37%   1.78 0.78 (NYSE:RDC)  ROWAN COMPANIES INC Capital Goods -20.68% 38.68% 5.62%   33.16% 38.76%   0.40 0.49 (NYSE:S)  SPRINT NEXTEL CORP Technology -13.65% 18.30% -11.24%   29.59% 25.61%   0.62 0.61 (NYSE:SEE)  SEALED AIR CORP Basic Material -3.95% 7.47% 4.13%   16.64% 15.47%   0.85 0.97 (NYSE:STZ)   CONSTELLATION BRANDS INC Consumer Non Durable 23.76% 12.62% -3.14%   17.06% 16.97%   0.54 0.45 (NASDAQ:SYMC)  SYMANTEC CORP Technology 6.36% 25.49% 4.69%   30.39% 27.15%   0.37 0.58 (NYSE:TAP)  MOLSON COORS BREWING CLB Consumer Non Durable 14.61% 6.14% -22.88%   17.95% 17.83%   0.49 0.46 (NYSE:TMO)  THERMO FISHER SCIENTIFIC Health 7.08% 19.36% 7.71%   14.90% 18.20%   0.56 0.50 (NYSE:TSO)  TESORO CORPORATION Energy and Extraction -47.31% 29.18% 29.18%   6.76% 6.19%   3.04 3.81 (NYSE:VZ) VERIZON COMMUNICATIONS Technology 2.94% 5.37% 4.16%   32.18% 32.05%   0.46 0.48 (NYSE:WAT)  WATERS CORP Capital Goods 5.94% 10.53% 6.93%   28.15% 27.30%   0.80 0.97

To identify potentially attractive investment ideas, The Applied Finance Group (AFG) uses a combination of proprietary variables including valuation, economic performance, management quality, and Earnings Quality. In December of 2008, ValueExpectations.com released a list of companies sorted only by AFG’s Value Score (defined below). Our valuation techniques have proven successful at identifying mispriced securities, which has helped our clients select stocks that outperform their chosen benchmark.

The ValueExpectations.com blog posted in December 2008 (High Value Score Stocks - S&P 500), contained these high Value Score companies (DDS, S, NOV, MTW, SII, WFR, CHK), and outperformed the S&P 500 by 40% as of our 3-26-09 performance update. We recently checked the average performance of those picks through 8-27-2009 to find that they have returned an astounding 52% above the S&P 500, with 6 of the 7 companies outperforming. High Value Score Stocks Part 2, released on 5-7-09 has also outperformed the S&P 500 by nearly 3% since its release, with a batting average of just over 60%.

Due to the success of the first two “High Value Score” blogs, we again used valuation as a basis for selecting a new set of investment ideas. Listed below are the top 10 companies in the S&P 500 (excluding Financials) based on AFG Value Score alone. These companies look the most attractive from a valuation perspective relative to the rest of the index.

Exchange/Ticker Name Sector Valuation Attractiveness (NASDAQ:CEPH)  CEPHALON INC Health Very Attractive (NYSE:PM)  PHILIP MORRIS INTL INC Consumer Non Durable Very Attractive (NYSE:DNB) DUN & BRADSTREET CORP Consumer Services Very Attractive (NYSE:S)  SPRINT NEXTEL CORP Technology Very Attractive (NYSE:FIS)  FIDELITY NATIONAL INFO Consumer Services Very Attractive (NASDAQ:APOL)  APOLLO GROUP INC CL A Miscellaneous Very Attractive (NYSE:AES) AES CORP THE Utilities Very Attractive (NYSE:AZO) AUTOZONE INC Consumer Services Very Attractive (NYSE:TSO)  TESORO CORPORATION Energy and Extraction Very Attractive (NYSE:TMO) THERMO FISHER SCIENTIFIC Health Very Attractive

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).

Healthcare reform has been a hot topic of discussion in the news and on blogsites all over the country as the Obama administration mulls over whether or not a public option for healthcare makes sense and what a plan like that would entail. Any new reform to the current healthcare plan would have a great effect on stocks within the Healthcare sector. Below is a list of stocks we find attractive and a few that we find unattractive within the S&P 500 Health sector. The chart consists of each company’s attractiveness as an investment opportunity using The Applied Finance Group’s (AFG’s) buy/sell criteria (explained below), and also grades each company based on expected Economic Margin (EM) change and valuation ranks within the sector. Companies expected to improve EMs and that have a more attractive valuation than their sector peers have proven through backtests to be more likely to outperform than stocks AFG views as overvalued and that have an expected decline in EMs.

 

Source (The Applied Finance Group)

*Valuation & EM Change are Ranks within their sector

AFG's Buy/Sell Criteria - factors in Economic Margin, Management Quality, and AFG's Valuation Metric. In order to determine Management Quality, AFG scores management on their growth decisions in accordance with the company’s ability to either create or destroy wealth. AFG's Valuation Metric measures a company's Percent to Target (the 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.

Every year Fortune releases a list of the 40 best companies to invest in now to retire on. This long-term portfolio is designed to protect your hard-earned nest-egg as you approach retirement.

Last year Fortune’s portfolio of 40 best stocks to retire on returned -23.07% from 6-20-08 to 6-16-09, relative to the -30.8% returned by the S&P500 during the same time period. This year they are replacing 23 stocks to form the new portfolio.

Provided below are the 40 stocks recommended by Fortune as the best stocks to retire on in 2009 and our outlook of these companies from a valuation perspective based on The Applied Finance Group’s valuation model.

 Fortune's 40 Best Stocks to Retire On - 2009

Related Stock Article:
Is Apple a Buy Hold or Sell?, Click Here to View

The Applied Finance Group’s (AFG’s) Economic Margin (EM) methodology helps investors understand what a company earns above its true cost of capital or how profitable a firm is. Companies expected to improve their Economic Margins have proven to be more likely to outperform than companies with expected EM declines. The table below provides 10 stocks expected to improve their Economic Margins in the next fiscal year and look attractive from a valuation perspective according to AFG’s valuation model. All 10 of these firms also currently have a default buy recommendation and look to have considerable long-term upside.

S&P 500 - Stocks to Watch (ex. Financials)

 

AFG's default valuation is a great place to start when looking for potential equity investments as our valuation techniques have proven successful through time at identifying mispriced securities and helping our clients identify investment opportunities resulting in outperforming their chosen benchmark.

AFG's Valuation Model – Using AFG’s modified discounted cash flow model to measure the intrinsic value of a firm compared to its peers. AFG's Value Score - 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.

Bloomberg provides a score for companies within the S&P 500 based on an average of all analyst ratings from the street. Below is a table highlighting companies with the best analyst ratings, largest increase in rating, highest price targets, and worst analyst ratings and the valuation attractiveness of each of these companies based on The Applied Finance Group’s (AFG) valuation model.

Companies within each of these groups are ranked from most attractive from a valuation perspective to the least attractive. VE.com will actively track the performance of these recommendations and see how they stack up to the analyst recommendations in each group. AFGview.com, AFG’s professional investor website allows you to compare any company using their rating versus the consensus ratings of the sell side. If you are interested in an analysis on a specific company, contact afgsales@afgltd.com.

 

Best/Worst Analyst Rated Companies (Bloomberg)

 

AFG's Valuation Model – Using AFG’s modified discounted cash flow model to measure the intrinsic value of a firm compared to its peers. AFG's Value Score - 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.

To identify potentially attractive investment ideas, AFG usually uses a combination of proprietary variables to develop of focused group of potential buy ideas that meet criteria based on valuation, economic performance, management quality, and Earnings Quality. In December of 2008 ValueExpectations.com released a list of companies narrowed only by the valuation properties of the company using AFG’s Value Score (defined below). Our valuation techniques have proven successful through time at identifying mispriced securities and helping our clients identify investment opportunities resulting in outperforming their chosen benchmark. .

The ValueExpectations.com blog posted in December 08 (High Value Score Stocks - S&P 500) contained these high Value Score companies (DDS, S, NOV, MTW, SII, WFR, CHK) had returned 40% above the S&P 500 as of our 3-26-09 performance update and a recent check of that performance on 5-5-09 was even better, currently these companies have returned an astounding 64.5% above the return of the S&P 500 during the same time period (12-29-08 to 5-5-09).

In this exercise we used valuation independent of other key proprietary variables we use to identify good investment opportunities. Although valuation works well on a stand-alone basis, it works even better when used with AFG’s Economic Margin, Management Quality, and Earnings Quality variables.

Listed below are the top 10 companies in the S&P 500 (excluding Financials) based on AFG Value Score alone. These companies all look the most attractive from a valuation perspective relative to the rest of the index.

AFG High Value Score Stocks

 

Valuation Model – Using AFG’s modified discounted cash flow model to measure the intrinsic value of a firm compared to its peers.

AFG's Value Score - 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.

Below is a summary of 22 AFG Buy Recommendations from the S&P500 Index. The report highlights the 2 companies from each sector (ex. financials) that have the most attractive value score and are currently rated Buys by The Applied Finance Group, Ltd. (AFG). Factors used to derive a AFG’s recommendation include: Expected change in Economic Margins, Intrinsic Value, and Management Quality.

We also ran a VE analysis and provided the results. The VE analysis of each company is used to identify implied sales growth expectations versus what the company has delivered historically in sales growth over the past 5 years. Measuring the spread between a company’s VE sales growth expectations and what it has historically delivered should give you a good idea of which companies have the best chance of meeting or exceeding those expectations, and thus are more likely to outperform.

 

 Cheapest Companies In The S&P 500 By Sector (ex. Financials)

 

 Click Here, to see results of our portfolio performance using AFG's Buy/Sell criteria

A brief description of AFG'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.

 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.

VE Sales Growth - AFG’s Value Expectations allows us to understand the Sales Growth, EBITDA Margin, and Asset Turnover a company has to deliver in the future to justify its current trading price. In theory, if the imbedded future performance is very conservative relative to the company’s historical performance, the stock is regarded as undervalued. The VE Sales Growth displays the implied future Sales Growth of the company assuming their EBITDA Margins and Asset Turnovers stay at the 5 year historic median levels.

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.

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)

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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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.

Here is a list of companies, two from each sector within the S&P 500 that are expected to improve their Economic Margins (EM) the most over the next two years along with the bottom two in each sector expected to have their EM’s deteriorate the most. Companies expected to improve their EM’s more than their sector peers have proven to be more likely to out-perform. Improving EM’s coupled with low expectations priced-in for sales growth are the companies on this list that may be worth a look as a potential investment.

Also included in this table is the implied sales growth priced-in over the next five years in order to justify the stock’s current trading price compared with their achieved 5 Year Median Sales Growth. Ask the question are the expectations for sales growth realistic compared with what revenue growth the firm has delivered in the last five years.

If you would like to learn more about the Economic Margin methodology or Value Expectations feel free to contact an AFG representative to schedule a web-demo at support@afgltd.com.

 

S&P 500 Companies with the Biggest Forecasted Change in Economic Margins

 

According to Bespoke Investment Group, these ten companies have the highest percentage of Buy ratings from the analysts that follow them. This table shows the number of analysts covering each stock and the number of buy and sell ratings as well as the percentage of buy ratings on the top 10 companies from Bespoke. Also in the table is the achieved 5 year median sales growth and the VE Sales growth (Sales Growth expectations priced in to the stock at today’s price). Only the top 4 companies on the list LO, PM, TMO, and AYE have 100% buy ratings from all analysts. Of those four, only AYE has high expectations relative to what they have delivered in sales growth in the past. Six out of the twelve companies on the list LO, PM, TMO, GOOG, COV, and BLL have very realistic expectations for sales growth priced-in compared to what they have been able to achieve. With the high percentage of buy ratings on these stocks they all deserve a more in-depth look, but the six with low expectations look especially worthy of consideration as potential investments.

S&P 500 Stocks with the Highest Percentage of Analyst Buy Ratings.

*denotes company only has 2 years of historical sales growth
**denotes company only has 3 years of historical sales growth
VE Sales Growth was calculated for these companies on 12/12/08.