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Introduction

Whenever there is a rise in stock values, as we have experienced over the past year or so, it seems to be human nature to automatically assume that valuations have become too high. However, although it is possible that this is true, it is not necessarily so. A lot has to do with where valuations were before the run-up occurred. For example, if valuations were extremely low, then even after a rise, they can continue to be low or perhaps only have risen to becoming fairly valued.

On the other hand, if valuations were already extended prior to the run, then current valuations may have become dangerously high. The important point here is that valuation is a very relative concept. Moreover, we would argue that valuation needs to be evaluated on a company-by-company basis. This is simply an extension to the concept that it is a market of stocks, rather than a stock market, as we introduced in our last article found here.

A Good Run Broadly Based

The following graph, courtesy of the leading financial blog, Seeking Alpha, clearly illustrates just how good and how broad recent stock price rises have been. We suggest the reader focus on the one year, and year-to-date numbers first and foremost. However, the last three months are impressive as well.

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This next graphic, once again courtesy of Seeking Alpha, breaks the recent rise in stock prices more specifically by sector. Once again, we discover that even amongst a lot of reporting of doom and gloom, and even considering several dire forecasts that stock markets were set to collapse, recent performance has been rather strong. Therefore, we feel safe in stating that we have actually been in a bull market over the last year or so.

On the other hand, and to stay true to our thesis that it is a market of stocks and not a stock market, we offer the following qualifier. It has been our experience that in every market, whether it is a bull market or a bear market, there will always be individual stocks that are overvalued, undervalued or fairly valued. Therefore, it's up to the individual investor to put in the effort and to do the necessary work to find them.

Common sense would tell us that there will be more overvalued individual stocks in a bull market, and conversely, there will be more undervalued stocks in the bear market. Nevertheless, we contend that the discerning investor willing to do his or her homework can find good value in any market environment. This recent bull market is no different, as we will demonstrate later in this article. Note that this perspective is in addition to what we offered in our introductory remarks.

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Mining the S&P 500 for Value

Even though the S&P 500 is comprised of 500 individual stocks, thanks to the FAST Graphs™ research tool, it is a rather easy matter to review each constituent of this large universe one company at a time. In fact, that is precisely what I did. I started with reviewing the index in alphabetical order, then I ran the group by estimated total return to provide a perspective of valuation, and then by dividend yield order. This aggregate portfolio review allowed me to ascertain a good feel for the relative valuation of the index as a whole. But even better than that, since it was based on a review of each of the component parts, my insights were greatly enhanced because I went through each individual graph on all 500 constituents one at a time.

Again, thanks to the efficiency of the FAST Graphs™ research tool, this was a relatively easy task that I was able to accomplish in approximately one hour. To me, the result was nothing short of amazing. Once I completed this exercise, my perspective and feeling of the relative valuation of the S&P 500 as an index, but based on reviewing each individual company, resulted in what I felt was a much deeper understanding than any mere review of statistics could ever have provided me.

Moreover, what I discovered supports my general thesis previously stated above "that in every market, whether it is a bull market or a bear market, there will always be individual stocks that are overvalued, undervalued or fairly valued." By carefully dissecting the S&P 500 one company at a time, I was able to find all of the above. The remainder of this article will provide sample examples of undervalued, overvalued and fairly valued companies on several different categories of stocks that are in the S&P 500.

It is important to state in advance that what follows is not intended to be a comprehensive list. Instead, we are simply offering a few examples to illustrate the validity of the concept that it is a market of stocks. However, an additional benefit to this exercise is the vivid illustration that companies come in all different sizes, shapes and flavors. Furthermore, although we will focus primarily on examples of various categories of companies that appear to be in value, we will include a few overvalued examples for perspective at the end.

(Note: For the reader's information and convenience, follow this link to a portfolio review of the complete list of the S&P 500 constituents and key fundamental metrics presented in order of highest total estimated return to lowest based on current valuation and estimates of future growth. The results may astound you.)

Fairly Valued To Undervalued S&P 500 Dividend Growth Stocks

Three examples of fairly valued and or undervalued S&P 500 dividend growth stocks would include, but is not limited to Hasbro (NASDAQ:HAS), Aflac (NYSE:AFL) and Microsoft (NASDAQ:MSFT). Since a picture is worth 1000 words, we offer the following historical and forecasting graphs on Hasbro Inc.

Hasbro Inc

The market has historically priced Hasbro at a normal PE Ratio of 15.8 (blue line). Currently the market is pricing Hasbro at a PE ratio of 13.6. Additionally, the company is trading at a price to sales ratio of 1.20 that is low by historical standards.

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The consensus of 14 analysts reporting to Capital IQ forecast forward earnings growth at 8.5%. This would imply a fair value PE Ratio of 15. However, currently Hasbro is trading at a discounted PE Ratio of 13.6.

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Fairly Valued To Undervalued S&P 500 High-Yield Stocks

Three examples of fairly valued high-yield stocks would include RR Donnelly & Sons (NASDAQ:RRD), Cliffs Natural Resources Inc. (NYSE:CLF) and Altria (NYSE:MO). Once again, since a picture is worth 1000 words, we offer a sample historical earnings and price correlated graph, and a forecasting graph on R&R Donnelley & Sons. As a caveat, we are not necessarily recommending this stock (or any others that we feature later on), but simply providing an example of a high-yield opportunity that appears undervalued. The reader is encouraged to conduct their own due diligence.

RR Donnelley & Sons

The market has historically priced RR Donnelley & Sons at a normal PE Ratio of 15.1 (blue line). Currently the market is pricing RR Donnelley & Sons at a PE ratio of 6.4. Additionally, the company is trading at a price to sales ratio of .20 that is low by historical standards.

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The consensus of 7 analysts reporting to Capital IQ forecast forward earnings growth at 7.5%. This would imply a fair value PE Ratio of 15. However, currently RR Donnelley & Sons is trading at a discounted PE Ratio of 6.4.

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Fairly Valued To Undervalued S&P 500 High-Growth Stocks

High growth stocks are categorized by a significantly above-average historical earnings growth rate, coupled with a forecast for significantly above-average growth going forward. However, future growth does not necessarily need to equal past growth, and most importantly, current valuation should be given a higher weighting based on forecast growth than on historical growth.

Three examples of high-growth companies that appear to be undervalued are DirecTV (NASDAQ:DTV), Fossil Inc. (NASDAQ:FOSL) and how could we exclude Apple (NASDAQ:AAPL). Again, since a picture is worth 1000 words we provide the following earnings and price correlated historical graph and a forecast graph on DirecTV.

DIRECTV

The market has historically priced DIRECTV at a normal PE Ratio of 18.7 (blue line). Currently the market is pricing DIRECTV at a PE ratio of 13.3. Additionally, the company is trading at a price to sales ratio of 1.19 that is low by historical standards.

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The consensus of 25 analysts reporting to Capital IQ forecast forward earnings growth at 21.1%. This would imply a fair value PE Ratio of 21.1. However, currently DIRECTV is trading at a discounted PE Ratio of 13.3.

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Fairly Valued To Undervalued S&P 500 Cyclical Stocks

We define cyclical stocks as companies that may achieve an above-average long-term record of earnings growth; however, the achievement of this growth often occurs in fits and starts. Three examples of fairly valued cyclical stocks would include Caterpillar Inc (NYSE:CAT), Cummins Inc (NYSE:CMI) and Deere & Co (NYSE:DE). Again, since a picture is worth 1000 words, we include a historical earnings and price correlated graph and a forecasting graph on Deere & Co.

Deere & Co

The market has historically priced Deere & Co at a normal PE Ratio of 17.3 (blue line). Currently the market is pricing Deere & Co at a PE ratio of 10.7. Additionally, the company is trading at a price to sales ratio of .92 that is low by historical standards.

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The consensus of 22 analysts reporting to Capital IQ forecast forward earnings growth at 11.7%. This would imply a fair value PE Ratio of 15. However, currently Deere & Co is trading at a discounted PE Ratio of 10.7.

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Fairly Valued To Undervalued S&P 500 Turnaround Stocks

In many ways, turnaround stocks could also be considered cyclical. However, in the context of this article we're referring to stocks that although they have checkered pasts, are forecast to produce accelerated earnings growth going forward. Three examples of turnaround stocks include Goodyear Tire (NASDAQ:GT), Southwest Airlines (NYSE:LUV) and Ensco PLC (NYSE:ESV). We include the historical earnings and price correlated graph and a forecasting graph on Ensco PLC.

Ensco PLC

The market has historically priced Ensco PLC at a normal PE Ratio of 23.2 (blue line). Currently the market is pricing Ensco PLC at a PE ratio of 12.4. Additionally, the company is trading at a price to sales ratio of 3.36 that is low by historical standards.

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The consensus of 29 analysts reporting to Capital IQ forecast forward earnings growth at 16%. This would imply a fair value PE Ratio of 16. However, currently Ensco PLC is trading at a discounted PE Ratio of 12.4.

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A Sampling of Overvalued S&P 500 Stocks

As stated in our introductory remarks, there will also exist overvalued stocks that can be found in any market whether it be bear or bull. The following three examples are comprised of S&P 500 constituents that are currently being priced at what we consider to be inexplicably high valuations.

Whole Foods Market (NASDAQ:WFM)

The market has historically priced Whole Foods Market Inc at a normal PE Ratio of 32 (blue line). Currently the market is pricing Whole Foods Market Inc at a PE ratio of 39. Additionally, the company is trading at a price to sales ratio of 1.64 that is high by historical standards.

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The consensus of 24 analysts reporting to Capital IQ forecast forward earnings growth at 19.9%. This would imply a fair value PE Ratio of 19.9. However, currently Whole Foods Market Inc is trading at a Premium PE Ratio of 39.

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Range Resources Corp (NYSE:RRC)

The market has historically priced Range Resources at a normal PE Ratio of 24.8 (blue line). Currently the market is pricing Range Resources at a PE ratio of 120.4. Additionally, the company is trading at a price to sales ratio of 7.87 that is high by historical standards.

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The consensus of 35 analysts reporting to Capital IQ forecast forward earnings growth at 0%. This would imply a fair value PE Ratio of 15. However, currently Range Resources is trading at an extremely high PE Ratio of 120.4.

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Lennar Corp (NYSE:LEN)

The market has historically priced Lennar Corp at a normal PE Ratio of 10.9 (blue line). Currently the market is pricing Lennar Corp at a PE ratio of 41.4. Additionally, the company is trading at a price to sales ratio of 2.00 that is high by historical standards.

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The consensus of 20 analysts reporting to Capital IQ forecast forward earnings growth at 6%. This would imply a fair value PE Ratio of 15. However, currently Lennar Corp is trading at a high PE Ratio of 41.4.

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Summary and Conclusions

There were several objectives and goals that we hoped to accomplish by writing this article. First and foremost we offer it as additional evidence validating our notion of a market of stocks rather than a stock market. We hope that we have provided enough examples that illustrate how different individual companies can be in relation to each other. Therefore, we believe this provides additional evidence of why we eschew talking about markets in general in favor of focusing on individual stocks based on their own specific merits.

A second, but perhaps equally or even more important objective, is to illustrate how vague and generalized notions about valuation can be very misleading. As a case in point, we think it's a sad commentary that so many investors today are avoiding equities at precisely a time when valuations are providing extraordinary opportunities. These opportunities can be found in both long-term growth of principal as well as attractive and growing dividend yields.

The following report from Financial Advisor Magazine on September 17, 2012 corroborates our concerns:

"September 17, 2012
Despite Low Interest Rates, Bond Funds Gain Over $1.1 Trillion Since '08

Long-term mutual fund inflows were just $20.7 billion in August, with open-end U.S.-stock funds facing yet another month of outflows, losing $14.3 billion, according to Morningstar Inc.

Additional highlights from Morningstar's report on mutual fund flows:

• Investors poured $26.4 billion into taxable-bond funds ($30.0 billion if ETF flows are included) and another $5.6 billion into municipal-bond funds in August. Altogether, inflows into these funds surpassed $1.1 trillion since the end of 2008 when the Fed cut rates to zero.
• U.S.-stock mutual funds and ETFs bled $22.4 billion in August, making it the worst month in two years and the fifth worst during the past five years for the asset class.
• International-stock funds had $2.8 billion in outflows, the group's worst showing since December 2011.
• Investors seem to have lost their taste for world-bond and inflation-protected bond funds. These two former market darlings absorbed just over $600 million in combined August inflows.
Old Westbury burst on the scene in August with inflows of $1.4 billion, while the American Funds logged another $5.5 billion in outflows, Morningstar said."

This pessimistic investor behavior is especially tragic when you consider that the S&P 500 has averaged producing returns in excess of 15% since the beginning of 2009 (the last approximately four years). Investors who were traumatized by what happened in 2008 were willing to accept virtually zero returns instead because they were afraid, at precisely the time when US equities had gone on sale. Instead they should be following Warren Buffett's sage advice: "Be greedy when others are fearful and fearful when others are greedy."

After conducting the research cited above, we have concluded that there remains a lot of opportunity for solid returns at reasonable levels of risk in today's market environment. However, the trick is in separating the wheat from the chaff. Not all companies are good investments at this time, but we do believe that there are more good ones out there than many suspect.

This, part 1, of what will be a series of articles, postulated the foundational notion that there is a lot of value in this market. Future installments will cover specific examples of companies that we believe represent good value at reasonable risk levels based on valuation. We intend to provide examples covering the five broad categories that we presented in this article. To reiterate, the companies we will cite will not be all-inclusive, but instead will represent examples of companies offering growth, yield, or a combination of both, again, at reasonable levels of risk.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

Source: There Is A Lot Of Value In This Market: Part 1