UFS

We constantly read about stock market phenomenons that occur that create a unique investment opportunity. One that caught our eye last year was the January Effect, and we were hoping that it would prove true as the market had already fallen off following the financial meltdown in September of 2008. However, the January effect only materialized in part, as we witnessed nearly a 10% drop in the month of January 2009, marking the second consecutive year the January Effect has not been very effective. However, the market was up overall for the full year. The January Effect is a theory that says the stock market tends to rise the month of January as investors are buying up stocks, due to recently selling before the end of the year for tax purposes. The January Effect also notes that small cap stocks tend to outperform large cap stocks. This theory was first discovered by a Univ. of Chicago grad student Donald Keim in the 1980’s.

The part of the theory that small cap stocks tend to outperform large cap stocks has held true many times throughout history (only 6 years since 1980 did large caps outperform small caps 1982,1987,1989,1990 and 2008, 2009). One criticism of this strategy is that it is difficult to profit from this theory because the market expects the January Effect to happen and prices adjust accordingly.

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Another part of the theory is that the performance of the market in January, especially the first five days, is used as a predictor and will set the trend for the performance of the market the remaining eleven months of the year.

• 85% of the time the S&P 500 has seen a rise the first five days of the year, the index has followed suit the remainder of the year.

• 32 of the last 39 years the performance of the S&P 500 has followed the direction of the index in January for the following 11 months.

Recap of 2009:

First five days the market was down (2009 The Market Closed Up)

Large cap stocks outperformed small cap stocks (It may be coincidence or it may be a trend but the last two years large caps outperformed small caps)

In this exercise we will take a list of small cap companies that we released last week (7 out of 10 are up so far and the group as a whole has currently outpaced the Russell 2000 by 2.88%) that look undervalued from a valuation standpoint and track the performance through January to see if the small caps we find attractive will keep with the trend. If small caps are most likely to outperform and VE believes that these 10 firms are the most likely to outperform from the Russell 2000, then this is a list you may want to consider as potential investment opportunities.

As a further layer of analysis the chart below is an example of The Applied Finance Group's (AFG’s) proprietary Intrinsic Value Chart which provides insight into how well AFG has tracked the company through time and how the company currently fares according to AFG’s default valuation model. The company example we are providing is Imperial Sugar Company (NASDAQ:IPSU), one of the small caps companies from last week’s list that AFG has tracked well and looks undervalued. Also provided below is a map of the components of the Intrinsic Value Chart as well as how to interpret the chart and the important things to look for.

We will revisit these companies in February to see how they fared vs. large caps and to see what the overall performance of the market in January will predict for 2010.

AFG’s Intrinsic Value Chart:

• Identifies entry/exit points

• Shows how well AFG has tracked the company (accuracy)

• Displays the trading range of the company each year through time (blue bars)

• Displays the end of year closing price (dash on blue bar)

• Displays AFG’s default intrinsic value (red dotted line)

How to Read this chart:

• The Blue Bars represent the high and low trading range for a stock for each calendar year.

• The red dotted line represents Applied Finance Group’s (AFG’s) historical Intrinsic Value through time.

• When the red line (Intrinsic Value) is above the blue bars (trading range) the company looks to be undervalued.

• When the red line (Intrinsic Value) is below the blue bars (trading range) the company looks to be overvalued.

Below is an example of AFG’s Intrinsic Value Chart and the important things to look for within the chart.

To stay updated on companies AFG believes are attractive investment opportunities register for ValueExpectations.com It's Fast and Free!

The Applied Finance Group's (AFG’s) valuation techniques have proven successful at identifying mispriced securities. Clients use the tools built by AFG to identify investment opportunities in order to outperform their benchmarks. Normally when searching for attractive investment opportunities, AFG uses, along with Valuation, a combination of proprietary variables that include Economic Performance (EM), Management Quality, and Earnings Quality. Although our valuation variable (Value Score) works best in concert with our other proprietary variables, AFG’s valuation metric also works well on its own.

To stay updated on companies AFG believes are attractive investment opportunities register for ValueExpectations.com It's Fast and Free!       

For those investor’s who focus on small to mid cap stocks from the Russell 2000, we have provided a list of companies with the most attractive valuations within the index.

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.

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.

To stay updated on companies AFG believes are attractive investment opportunities register for ValueExpectations.com It's Fast and Free!

Many of the institutional clients of The Applied Finance Group, Ltd. (AFG) tend to focus on large cap stocks and benchmark themselves against the S&P 500 Index, which is why many of the buy ideas from ValueExpectations.com usually come from the large cap index. For those investor’s who focus on small to mid cap stocks from the Russell 2000, we have provided a list of companies with the most attractive valuations within the index.

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.

Besides valuation, another thing AFG takes into account is a company’s Economic Margin (EM) which measures the true economic profitability a company earns above or below its cost of capital and more importantly the expected change in EM’s. Companies expected to improve their EMs have proven through backtests to be more likely to outperform than those with EMs that are expected to decline. The list below contains 10 stocks that are expected to improve their Economic Margins at a greater rate than their sector peers, have attractive valuations and rate as attractive based on AFG’s overall investment opportunity criteria.

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.

As some investors may believe the market is starting to show "signs of recovery", many of the over 200 institutional firms The Applied Finance Group (AFG) works with can always take advantage of identifying mispriced securities. While some of AFG’s clients might have a specific focus on growth or value, most subscribe to the practice of buying growth at a discount (growth at a reasonable price GARP) and avoiding  “value traps.”

In October 2008 AFG released the study, Then and Now, discussing the low expectations priced into the market "Today many world-class franchises are available at expectations reflecting a very bearish future. Over 150 companies in the S&P 500 (industrials) have negative sales growth expectations embedded into their current market valuations". Following that study AFG issued another study, Analyzing Market Troughs and Rebounds, which pointed out that historical market recoveries have been typically dominated by value stocks.

Whether you are looking for value or more growth oriented securities, we have provided a list of  companies in various asset classes, Large Cap Growth, Large Cap Value, Small Cap Growth, Small Cap Value that are currently on AFG’s Buy and Sell list. If you are a professional investor and would like to view a complete buy and sell list or take a trial of AFG's valuation tools CLICK HERE.

Monthly Buy/Sell list Across the Market
The Applied Finance Group 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 4,500 covered securities. By 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 all investments. This focus List of stocks has outperformed the market on an annual basis by greater than 10% with our buy portfolio and underperformed the market by 10% with our sell portfolio. AFG clients then use Value Expectations to further analyze the expectations embedded in a security’s price (example of expectations embedded in the entire S&P500 over the next 5 years below) and to build out their own model to refine an intrinsic value of a company based on their own expectations.

Select Companies From AFG's Current Monthly Buy-Sell List

(Source: The Applied Finance Group)

Again, If you are a professional investor and would like to view a complete buy and sell list or take a trial of AFG's valuation tools CLICK HERE.

Model Portfolio Buy/Sell Results

To view how AFG defines the Large/Small and Growth/Value universe Click Here.

A brief description of some other of AFG's insights:

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.
AFG's Value Universe - Companies in the AFG universe, which have MV/IC at the bottom 50% of the universe and have EPS estimates.

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.