By Michael Kaye, CFA The eternal question for equity investors: Which stocks have the greatest potential for price appreciation? This week, we decided to combine some of Standard & Poor's investing metrics to help identify some good candidates.
We started with S&P's Fair Value rankings. This 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.
ALL'S FAIR. 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, and the current prices of the stocks in Tier 1 substantially exceed their fair value.
The fair-value system has had a pretty good track record so far in 2004. Year-to-date through Apr. 30, S&P's fair-value model portfolio was up 5.2%, vs. a 0.4% decline for the S&P 500.
In this week's screen, we searched 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 that was more than double the recent stock price.
Then we harnessed S&P's fundamental analysis. We looked for issues trading at least 50% below the 6- to 12-month target price established by analysts at S&P Equity Research.
Our screen turned up these eight names, each of which carries a fair value ranking of 5:
Fairest Values of Them All?
Dura Automotive (DRRA)
Fairchild Semiconductor (FCS)
Photon Dynamics (PHTN)
RF Micro Devices (RFMD)
URS Corp. (URS)
Varian Semiconductor Equipment (VSEA)
Vishay Intertechnology (VSH)
Kaye is an analyst for Standard & Poor's Portfolio Services Kaye is an analyst for Standard & Poor's Portfolio Services