What are we looking for?
Today we look for some of the most discounted U.S.-listed stocks that are also producing positive economic profits. Our goal with this screen is to try to differentiate real opportunities from potential value traps.
The screen
We screened the S&P 500, using with the following criteria:
- An economic performance index, or EPI (return on capital divided by cost of capital), greater than 1.0. An EPI ratio of 1.0 or more indicates a company’s capacity to create wealth for its shareholders (a higher EPI displays a greater rate of wealth creation);
- A negative future-growth-value-to-market-value ratio. FGV represents, in percentage, the portion of the market value that exceeds the company’s current operating value. The higher the number, the higher the baked-in premium for expected growth and the higher the risk. A negative number reflects a discount. For example, a future growth value of minus 50 per cent means that the market value would need to increase by 50 per cent to equal what the company is worth if its operating profit stays flat forever;
- A return on capital of 10 per cent or more;
- A positive 12-month return on capital change;
- The 12- and 24-month sales change is displayed to easily weed out companies that have seen their return on capital increase “artificially,” without top-line growth;
- A positive free-cash-flow-to-capital ratio. This ratio gives a sense of how well the company uses the invested capital to generate free cash flows, which could be used to stimulate growth, pay and/or increase dividends, reduce debt, etc. A positive figure is good – 5 per cent and above is excellent.
More about StockPointer
StockPointer is a fundamental analysis tool based on an EVA (economic value-added) model to quickly and easily identify investment opportunities. In addition to providing detailed reports on more than 7,500 companies (Canadian stocks, U.S. stocks and American depositary receipts), StockPointer also allows investors to create personalized filters and build custom portfolios.
What did we find?
Among the 14 companies that fit our criteria, two groups can be distinguished. 1) Companies that are experiencing headwinds, major headwinds in some cases, and 2) companies that are growing quickly. Interestingly, many companies of the second group are currently as discounted, or more, than companies of the first group. DXC Technology, HCA Healthcare, Western Digital, Cardinal Health and Davita all offer positive revenue growth both on the 12- and 24-month horizons. DXC Technology, which resulted from the merger between Computer Sciences Corp. and the Enterprise Services business of Hewlett Packard, offers one of the highest EPIs at 3.6 and a high return on capital of 28 per cent.
Unlike other companies in the list, DXC Technology's revenues are growing rapidly while the market value is still discounted by 16 per cent. Michael Kors, Kellogg, eBay, Conagra Brands and Ralph Lauren can seem attractive at first sight given their future-growth-value discounts, but their inability of generating positive revenue growth tells another story. In this case, the current discount might be there for a good reason, and this profile is typical of value traps: They are discounted, but they can stay discounted for a very long time, if not forever.
Investors are advised to do additional research prior to investing in any of the companies mentioned.
Jean-Didier Lapointe is a financial analyst at Inovestor Inc.