One helpful way to find potentially undervalued opportunities is from the "godfather of value investing" himself, Benjamin Graham.
Graham created an equation to calculate the maximum fair value for a stock, referred to as the Graham Number. Any stock trading at a significant discount to this number would appear undervalued.
For this list we focus on S&P 500 companies.
We used the Graham Number to screen for potentially undervalued stocks among a universe of S&P 500 stocks that beat the industry average in all of the following ratios:
- Gross margin
- Operating margin
- Pre-tax margin
Want a closer look at these terms and why they're valuable tools in investing? No problem! Let's review:
Market capitalization (market cap): Market capitalization, commonly referred to as market cap, is the total market value of a company's outstanding shares. It can be thought of as a measure of company's size. It can be calculated by multiplying the number of shares by the current price of the shares.
Graham Number: According to Benjamin Graham, a former mentor of Warren Buffett and the so-called "Godfather" of value investing, the Graham Number is the maximum price that a value investor should pay for a given stock. A stock whose share price is below the Graham Number is considered to be undervalued or of good value.
It is a calculation for the fair-value price of a stock based on its earnings per share (EPS) and most recent quarter's book value per share (the value of the company's assets divided by the number of shares).
The Graham Number = Square Root of (22.5) x (TTM EPS) x (MRQ Book Value per Share).
We use trailing 12 month (TTM) diluted EPS. Trailing 12 months (TTM) is an indication that the calculated data has come from the last 12 months.
TTM gross margin: This metric that tells us the percentage of a company's revenue is left after paying all production expenses. Costs include overhead, payroll, and taxation. ((revenues-cost of goods sold) / Revenue) *100 = Gross margin % TTM
Operating margin: This tells us the percentage remaining after all operating expenses are paid. Operating expenses include: supplies, repairs, research and development, and depreciation. (Operating Income / Net Operating Revenue) *100 = Operating Margin % TTM
Pre-tax margin: A company's earnings before taxes. This incorporates all of the expenses associated with business excluding taxes. It can help to determine the overall operating efficiency of the firm. The higher the pre-tax margin, the more profitable the company. (Net profit before taxes / net sales) *100 = Pre-tax Margin
Now that you're armed with information, take a look at our profitable stocks below. Do you think their current prices are truly undervalued, as suggested by Graham? Use the list as a starting-off point for your own analysis.
List sorted by potential upside. (Click here to access free, interactive tools to analyze these ideas.)
1. Wells Fargo
2. Duke Energy
3. M&T Bank
4. Public Service Enterprise Group
5. Sealed Air
6. Pinnacle West Capital
8. American Electric Power
9. Unitedhealth Group,
10. People's United Financial
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 Becca Lipman does not own any of the shares mentioned above.
The Motley Fool owns shares of UnitedHealth Group. The Fool owns shares of and has created a ratio put spread position on Wells Fargo. Motley Fool newsletter services have recommended buying shares of UnitedHealth Group. Motley Fool newsletter services have recommended creating a diagonal call position in UnitedHealth Group.
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