S&P 500 companies are at their cheapest valuations in 26 years, according to Alexis Xydias of Bloomberg. The Bloomberg report states that S&P 500 companies are expected to earn 18% more in 2011 than in 2010. Why, then, have prices been falling?
In spite of current and predicted earnings growth, stock prices have fallen, largely because of concerns over the global economy. Most recently, a possible Greek debt default has cast a gloomy shadow over markets.
David Bianco of Bank of America expects the S&P 500 index to reach the $1400 level by the end of the year (a 9.5% increase from the current $1278 price), according to Joe Weisenthal of Business Insider.
In the great search for value investments, we report a list of S&P 500 companies that appear to be undervalued, with a low price relative to earnings, earnings growth, and free cash flow.
The P/E ratio is a widely used tool for valuing a stock. The ratio indicates how much investors are paying for a dollar of earnings. For example, if a stock has a P/E ratio of 15, then investors are paying $15 for $1 of earnings.
P/E = (Share Price) / (EPS)
The PEG ratio is a measure of how much investors are paying for annual earnings (EPS) growth.
PEG = (P/E) / (Annual EPS Growth)
When a company appears overvalued because of a high P/E, taking into account earnings growth can standardize the measure, giving a ratio that is more comparable across firms. PEG ratios above one are seen as overvalued, whereas a PEG below one appears undervalued.
The P/FCF ratio is the relationship between a company's share price and how much cash it is generating.
Price/FCF = (Share Price) / (Free Cash Flow per Share)
Free cash flows are directly related to firm value, so the relationship between price and free cash flow per share is significant.
Based on the ratios below, do you think these stocks are undervalued?
List sorted by average ranking of P/E, PEG, and P/FCF ratios relative to their S&P 500 components. For each stock we'll list the ranking of the valuation ratio among all S&P 500 stocks. (Click here to access free, interactive tools to analyze these ideas.)
1. Capital One Financial
2. Micron Technology
3. American International Group
5. Hartford Financial Services Group
8. Ford Motor
9. Constellation Brands
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.
Kapitall's Andrew Dominguez does not own any of the shares mentioned above.
The Motley Fool owns shares of GameStop, Ford Motor, and AFLAC. The Fool owns shares of and has opened a short position on Bank of America. Motley Fool newsletter services have recommended buying shares of AFLAC and Ford Motor. Motley Fool newsletter services have recommended writing covered calls in GameStop.
Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.