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Using the Applied Finance Group’s (AFG) investment approach, we identified a list of small cap stocks that are likely to outperform the Russell 2000 index and are worthy of a closer look when considering new additions to your clients’ portfolios. This list includes 10 stocks that have two common qualities: (1) an expected improvement in Economic Margin, and (2) an attractive valuation.

AFG's default valuation is a great place to start when looking for potential equity investments, as our valuation techniques have proven successful over time at identifying mispriced securities.

To stay updated on companies AFG believes are attractive investment opportunities register here.

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Below are a few snapshots from AFG’s research tools providing some insight into why Luby’s Inc. (NYSE:LUB), a company from AFG’s consumer services sector, currently looks attractive. In the charts below you will see that there is a high correlation between the movements in Luby’s Economic Margin levels and its return vs. the S&P 500 index. With such a high correlation existing between the direction of a company’s EMs and its returns versus the S&P 500, it is a very good sign to see expected improvements in EMs for LUB.

In addition to understanding a company’s valuation, it is also very important to make sure that AFG has tracked the company’s stock well over time. AFG has a proven track record of identifying mispriced securities in the market. In the Intrinsic Value chart below, it shows that AFG has tracked LUB very well over time (accuracy score of 94) and that the company’s stock is currently trading at a discount relative to its default intrinsic value. A high accuracy score indicates that a company’s default intrinsic value has consistently been within the company’s annual trading range.

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 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 systematic analysis spans across growth and value stocks, all sectors, industries, and market caps with over 4,500 covered securities.

AFG's Wealth Creation Report is a 3 part chart :

The first chart is a summary of a company’s economic performance over time, as well as insight into how analyst EPS forecasts project AFG’s default EMs over the next two years.

• EM – Productive Capital = (Cash Flow minus Capital Charge excluding Intangibles) divided by the

Inflation Adjusted Productive Capital.

• EM – Invested Capital = (Cash Flow minus Capital Charge including Intangibles) divided the by

Inflation Adjusted Productive Capital.

•Val Score = Ranked Percent To Target for the current calendar yr. where 100 is the most undervalued

and 0 is the most overvalued (ranked across all firms in database with forecasts for 4,000 firms).

• EM Chg = One year out forecast EM minus last reported fiscal year's EM. Invested Capital EM is used.

The second part of the chart is the Asset Growth chart allows additional insight not only the growth of a company, but how that company’s growth strategy has affected their economic performance.

• Assets – Steady Growth (1 Yr) = The real growth rate at which a firm can increase its capital base

given internally generated cash, while maintaining a constant capital structure.

• Assets – Actual Growth (1 Yr) = Real year over year change in Inflation Adjusted Invested Capital achieved by the firm. Note: All actual growth is “actual”, i.e. 2007 growth represents growth from most recent quarterly balance sheet.

This data can then be used to identify how the stock has performed in relation to the market place.

• Return Net Market = The company's cumulative total return relative to the cumulative market-weighted average total return of the largest 2000 companies for the equivalent time period.

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.

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.

Disclosure: none

Source: Ten Undervalued Russell 2000 Small Cap Stocks