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I recently wrote an article about finding short candidates for when the market eventually does have a correction. In this article, I will be looking for undervalued potential long candidates for if the market continues its steady march higher. One of the most common comments I got from my short article, was that my screen was not thorough enough so I will look to correct that in this article by adding additional screening criteria, and adding additional valuation steps.

Goal #1: Select stocks that are large capitalization stocks.

Goal #2: Select stocks, which are profitable.

Goal #3: Select stocks that pay a dividend that is higher than the current 10-year Treasury rate, and that is growing.

Goal #4: Select stocks with increasing profitability.

Goal #5: Select stocks that are trading at a discount to fair value.

Screener Criteria

Step #1: Base List

I will be using the Zacks.com screener to get my initial base list of stocks that I will use additional criteria to refine the list. Using the screener criteria below, I found that 114 stocks met my screen, which will be my base list.

Market Cap: Great than $20 Billion [Enter 20000 in screener]

Dividend Yield: Greater than 2%

5-year dividend growth rate: Greater than 2%

PE Ratio [TTM]: Greater than 1

Exchange: NOT OTC

Step #2: Screen by Increasing Profitability

For this step, I took the 114 stocks in my base list and went to the Morningstar.com Financials page, and looked at the annual income statement for each stock. I only focused on one line of the statement, which was the net income line. To make it to the next step of my process the company had to have an increasing net income percentage every year for the last five years. After typing in one by one the tickers for each of the 114 stocks, I found that only nine stocks increased net income every year for five years. The nine stocks that made it through are in the table below with the net income percentage.

Symbol

Company

2008

2009

2010

2011

2012

JPM

JPMorgan Chase & Co

8.33%

11.68%

16.91%

19.52%

21.94%

HD

Home Depot Inc

3.17%

4.02%

4.91%

5.52%

6.07%

ACN

Accenture PLC

6.68%

6.86%

7.71%

8.33%

8.58%

BLK

BlackRock Inc

15.52%

18.62%

23.95%

25.74%

26.33%

CSX

CSX Corp

12.13%

12.74%

14.70%

15.52%

15.81%

MMC

Marsh & McLennan Companies Inc

-0.63%

2.16%

8.10%

8.62%

9.86%

SO

Southern Co

10.17%

10.85%

11.69%

12.84%

14.60%

ABV

Companhia De Bebidas ADR

24.71%

25.81%

29.97%

31.85%

32.60%

CM

Canadian Imperial Bank of Commerce

-55.47%

11.83%

20.29%

25.14%

26.54%

[Data from Morningstar Income Statement Page for each stock]

Step 3: DCF [Discounted Cash Flow] calculation of fair value

For my final step, I went to the Zacks.com page for each of the above nine stocks in step two to retrieve the EPS [TTM] and the projected long-term growth rate for each. I then used the data I retrieved and entered it for each stock into the DCF calculator on Smartmoney.com to see which stocks are undervalued. The assumptions I used for the calculator is that growth would last for five years and level off to 1% for every year thereafter. For my benchmark rate, I used longrundata.com to find the annualized total return of the S&P 500 (SPY) for the last 10 years. The annualized return of the SPY over that period is 7.83%, but I wanted to make this valuation section tougher, so I added the rate of inflation, which is 1.5% according the BLS [Bureau of Labor Statistics] to my 7.83% for a benchmark return of 9.33% to use in my DCF calculation. My data and the resulting DCF fair values for each stock are in the table below.

EPS

LT Growth

Current Price

Fair Value

JPM

5.59

7.79%

48.96

90.38

Undervalued

HD

3.07

16.00%

76.01

68.8

Overvalued

ACN

3.97

10.74%

80.48

72.32

Overvalued

BLK

14.18

11.93%

276.67

270.87

Overvalued

CSX

1.81

12.07%

25.43

34.77

Undervalued

MMC

2.23

12.00%

39.47

42.72

Undervalued

SO

2.73

4.76%

46.1

38.96

Overvalued

ABV

1.65

7.02%

42.43

25.72

Overvalued

CM

8.18

10.00%

78.59

143.92

Undervalued

Results

After going through the third and final step, I found that four stocks are currently undervalued. The stocks are JPMorgan Chase & Co. (JPM), CSX Corporation (CSX), Marsh & Mclennan Companies Inc. (MMC), and Canadian Imperial Bank of Commerce (CM). The table below shows important information for the final four companies that are undervalued.

Symbol

Company

Industry

Market Cap.

Div. Yield

% Undervalued

JPM

JPMorgan Chase & Co

Bank

$185.05 B

2.45%

-45.83%

CSX

CSX Corp

Railroad

$25.99 B

2.36%

-26.86%

MMC

Marsh & McLennan Companies Inc

Insurance

$21.76 B

2.33%

-7.61%

CM

Canadian Imperial Bank of Commerce

Foreign Bank

$31.41 B

4.64%

-45.39%

Thoughts & Observations

I was very surprised to see three financial related companies were on my final list of undervalued companies. I have not been a fan of financials but my screen is telling me that there is some value in financials and they could be worth a further look. I believe I was more thorough in my screening process than I was in the short article. By adding additional layers of criteria, I believe the four stocks that made my final list are all worth a deeper look as potential long candidates.

Disclaimer

Source: Long Candidates If The Tide Continues Rising