By Michael Kaye, CFA Searching for value plays amid a rising market? Standard & Poor's has developed a tool that may help investors identify such stocks. It's called the
Fair Value rankings. S&P's proprietary
quantitative model seeks to outperform the market by buying undervalued stocks and selling them when they reach maximum price appreciation.
The model calculates a stock's weekly fair value -- the price at which S&P believes an issue should trade at current market levels. The calculations are based on fundamental data such as earnings growth potential, price-to-book value, return on equity, and dividend yield relative to that of the S&P 500-stock index.
In addition to the fair-value price, each stock assessed under the model is ranked in one of five categories. Tier 5 is the highest ranking and contains stocks considered the most undervalued. These are issues with a fair value considerably greater than their current price, implying superior potential for price appreciation.
Stocks in the Tier 4 category are considered moderately undervalued, with fair value modestly higher than their current prices. Tier 3 includes stocks whose current prices most closely approximate their fair value. Tier 2 stocks are modestly overvalued, while the current prices of the stocks in Tier 1 substantially exceed their fair value.
DECENT FOLLOWING. The fair-value system has had a pretty good track record thus far in 2003. Year-to-date through Aug. 31, a portfolio of stocks with S&P's highest fair-value rankings was up 59%.
In this week's screen, we decided to search for issues that were trading at levels well below the fair value assigned by S&P's system. Using S&P's Stock Reports database, we looked for those issues with a fair value more than double the recent stock price.
While we didn't require that the stocks be followed by S&P analysts this time around, we did make sure each has at least three outside analysts covering it. Since an earnings component goes into the fair-value calculation, having at least three analysts covering the stock gives a better sample size for a consensus EPS estimate.
Our screen turned up these names, each of which carries a fair value ranking of 5:
Issues trading well below S&P Fair Value
Recent price (9/26/03)
S&P Fair Value (9/26/03)
Bally Total Fitness (BFT)
KB Home (KBH)
Orthodontic Centers of America (OCA)
Oxford Health Plans (OHP)
Triumph Group (TGI)
Kaye is a portfolio services analyst for Standard & Poor's