10 Undervalued S&P 500 Stocks – Including Valero Energy Corp. (NYSE:VLO) and MasterCard, Inc. (NYSE:MA)

Everything we do at The Applied Finance Group (AFG) ends with valuation, as it is the core of our research process. To come to realistic and insightful valuation conclusions, we must first understand how well a firm has utilized its invested capital and if that firm can earn above its true economic cost of capital. We define what a company earns above or below its true economic cost of capital as Economic Margin (EM) ™.

When you buy a company, you are essentially paying for its current assets plus its future expected performance. AFG determines the valuation of a company by forecasting future levels of its EMs and discounting cash flows back to today’s dollars. Two major ways in which we separate ourselves from traditional DCF models are that we incorporate the effects of competition by determining the competitive advantage periods (number of years its takes to compete away economic profits), and we assign company specific discount rates (rate at which cash flows are discounted back to today’s dollars adjusted for size and leverage)

Once we have a firm handle on whether or not a firm is profitable from an economic standpoint, the next goal is to correct some of the common distortions in “as reported” financial statements. As an example, traditional accounting metrics often punish technology and pharmaceutical firms for their R&D expenditures, and inflate retailers’ returns by ignoring their enormous off-balance sheet liabilities such as their operating leases. Our valuation framework essentially strives to create a set of economic financial statements for companies that work well across time, industries, sectors, and market capitalizations. We believe that this process puts us in a superior starting position when evaluating the attractiveness of any investment as we are comparing apples to apples, and not susceptible to the shortfalls of traditional accounting approaches to evaluating investments.

Many investors focus mostly on a company’s Earnings, while this is important, Earnings alone only account for 50-60% of the overall cash flow of a company. Our valuation process sheds light on the entire cash flow generation picture and helps investors better understand what the company is really worth. Focusing on earnings alone by using metrics such as earnings growth, price to earnings and ROE is helpful yet not sufficient in understanding a company’s ability to create wealth for its shareholders. The end goal is to link a company’s true economic performance to value, and in turn link those values to decisions for the betterment of your portfolios.

We provide money managers with access to a repeatable process of valuing companies that has proven to be effective at identifying investment opportunities regardless of the composition or characteristics of the individual company. To learn more about our valuation methodology and how we help hundreds of institutional investors refine their investment process, email us at support@afgltd.com.

The list of companies below are from the S&P 500 that look undervalued relative to their current price according to AFG’s valuation model. These companies deserve a deeper look as they have the makeup of potentially attractive investment opportunities.

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