Undervalued but Not Overlooked

Measuring a company's fair value against its stock price turned up some top-ranked names that trade at a discount

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.


  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?
Company/ticker S&P STARS Rank
Dura Automotive (DRRA ) 4
Emulex (ELX ) 5
Fairchild Semiconductor (FCS ) 4
Photon Dynamics (PHTN ) 4
RF Micro Devices (RFMD ) 4
URS Corp. (URS ) 4
Varian Semiconductor Equipment (VSEA ) 3
Vishay Intertechnology (VSH ) 5

Kaye is an analyst for Standard & Poor's Portfolio Services

Kaye is an analyst for Standard & Poor's Portfolio Services

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