When narrowing the market to a focus group of stocks to choose from, The Applied Finance Group (AFG) has a core set of principles we concentrate on to develop a group of stocks that are more likely to outperform the market. These variables include but are not limited to:
- Corporate Performance (Economic Margins): This determines the expected profitability of a company vs. their sector peer group.
- Valuation Using AFG’s valuation model: This variable helps determine which companies are most over/under valued within an index or sector.
- Earnings Quality: Companies that accumulate a high amount of accruals tend to experience negative earnings surprises more often.
- Management Quality: Companies that are profitable should look for investment opportunities while companies that are earning less than their cost of capital (negative Economic Margin’s), should focus on their core competencies and divest some of their bad assets.
Although this set of investment criteria has proven successful in generating buy ideas, AFG’s valuation on a standalone basis has consistently been able to identify mispriced securities and investment opportunities that outperform their chosen benchmark. Because this variable adds so much value when used by itself to pick stocks it is considered the starting point for any investment opportunity.
The chart below illustrates how well our valuation metric has performed across different indices and size/style categories:
(Click to enlarge)
*Please note: This bar chart highlights the annualized outperformance of the top half of Percent to Target (Valuation) versus the overall universe in green, and the annualized underperformance of the bottom half of Percent to Target (Valuation) versus the overall universe in red for a variety of various benchmarks in US equity markets.
*Please note: all backtest performance is from our US backtest system from 9/1998 through 10/2009, assuming monthly turnover.
Below are 15 companies within the S&P 500 that are attractive based on AFG’s valuation criteria alone, including Autozone Inc. (AZO) and Gilead Sciences (GILD):
|Rank Within Sector|
|15 Undervalued Stocks in the S&P 500|
|(NYSE:FCX)||FREEPORT-MCMORAN B||Basic Material||Attractive|
|(NYSE:GD)||GENERAL DYNAMICS||Capital Goods||Attractive|
|(NYSE:PM)||PHILIP MORRIS INTL||Consumer Non Durable||Attractive|
|(NYSE:AZO)||AUTOZONE INC||Consumer Services||Attractive|
|(NYSE:BBY)||BEST BUY CO.||Consumer Services||Attractive|
|(NYSE:WMT)||WAL-MART STORES INC||Consumer Services||Attractive|
|(NYSE:VLO)||VALERO ENERGY||Energy and Extraction||Attractive|
|(NYSE:MHS)||MEDCO HEALTH SOLUTIONS||Health||Attractive|
|(NYSE:BMY)||BRISTOL-MYERS SQUIBB CO||Health||Attractive|
|(NYSE:TMO)||THERMO FISHER SCIENTIFIC||Health||Attractive|
Disclosure: No positions