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.
Earnings Quality: Companies that accumulate accruals tend to have the most significant negative earnings surprises
Management Quality: Companies that are profitable should look for investment opportunities while companies that are earning less that their cost of capital (negative Economic Margin’s), should focus on their core competencies and divest some of their bad assets.
Model Accuracy: Because we start with a systematic approach, we want to make sure AFG’s model has effectively tracked historical trading ranges over time.
Each variable we use has been tracked in model portfolios since 1995 and all have proven to create alpha but are even more effective when you combine them together. However, the most significant variable is valuation. Because this variable adds so much value on a standalone basis, it is considered the starting point for any investment opportunity.
Valuation Metric Performance:
*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.
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ValueExpectations.com has developed two focus lists in the past by simply narrowing the S&P500 down based on Valuation alone and the results are encouraging:
The results of 2 previous Valuation only company lists:
12/29/2009 High Value Score Stocks: Outperformed the S&P 500 by 72.48% with a batting avg. of 85.7%.
5/7/2009 High Value Score Stocks part 2: Outperformed the S&P 500 by 2.25% with a batting avg. of 60%.
Below are 12 companies within the S&P 500 that are attractive based on AFG’s valuation criteria alone.
12 Stocks with Attractive Valuations - S&P 500