Stocks: S&P's Undervalued STARS

"Two great tastes that taste great together"the peanut butter cup approach to investing combines S&P's sector recommendations and STARS rankings

STARS rankings? Sector recommendations? Standard & Poor's disciplines for evaluating individual stocks—and the 10 sector groups that comprise the S&P 500 index—are each well known in their own right. How about a screen that unites the two, kind of like the inspired combo of peanut butter and chocolate in the old TV ads for Reese's Peanut Butter Cups? We thought it would be a good way to find a fresh list of attractive investing candidates for our readers.

To kick things off, we consulted the STARS. S&P's Stock Appreciation Ranking System (STARS) is a qualitative stock-ranking system based on fundamental research conducted by S&P's own equity analysts. We sifted our database for the list of companies ranked 5 STARS (strong buy), meaning that S&P analysts expect them to outperform the Standard & Poor's 500-stock index by a wide margin over the coming 12 months on a total return basis, with the shares rising in price on an absolute basis.

Next, we turned to our sector analysis. S&P Equity Research issues recommendations of "overweight," "marketweight," and "underweight," indicating the proportionate weight a particular sector should have in an investor's portfolio. The sector recommendations are market-cap weighted, influenced by economic, fundamental, and technical considerations. For this screen, we looked for stocks that were members of the sectors that currently carry an "overweight" recommendation from S&P: Consumer Staples and Health Care. ( readers can get more detailed info on industry groups by clicking on the Sectors & Industries tab at the top of the Company Insight Center page.)

Narrow Cut

We wanted to fine-tune the list to make sure we turned up some attractive names. So we turned to one of our proprietary measures, S&P's Fair Value model, a quantitative stock-ranking system. The model calculates a stock's weekly Fair Value—the price at which it should trade at current market levels—based on fundamental data such as corporate earnings and growth potential, return on equity, current yield relative to the S&P 500, and price-to-book value.

Stocks are ranked from 5, indicating significant undervaluation compared to the Fair Value universe, to 1, indicating significant overvaluation. We looked for those issues ranked 5.

This was a tough list, and only four stocks made the cut—three health-care outfits and one consumer staples name that's closely associated with health care. One of them, Genzyme (GENZ), was featured as S&P's Focus Stock for the week of June 11 (see, 6/11/07, "Genzyme: Geared for Growth").

Company Sector Investment rationale
CVS Caremark (CVS) Consumer Staples Increased generic drug sales, valuation
Genzyme Corp. (GENZ) Health Care Valuation
Wellcare Health Plans (WCG) Health Care Valuation
Zimmer Holdings Inc. (ZMH) Health Care Valuation
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