Stocks & Markets March 28, 2010, 9:29PM EST

Alternative Ways Retail Investors Can Value Stocks

Bloomberg BusinessWeek asks if such valuation tools as EVA and Market Topographer can surpass the traditional price-earnings ratio

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Wall Streeters may now have cause to be more confident about stock valuations than at any time in the last two years. That's a result of continually improving economic data, a consensus forecast by analysts for 30% higher earnings for the Standard & Poor's 500-stock index in 2010, expectations of lower unemployment, and the prospect of continued low inflation and interest rates. On Mar. 23, the S&P 500 index closed above 1,170 for the first time in 18 months, putting the broad market at 15 times the consensus earnings forecast of $78 a share for 2010.

Alec Young, equity strategist at Standard & Poor's Equity Research, believes the 15 times multiple constitutes a valuation ceiling until the market sees either dramatically improved monthly jobs numbers or more likely, first-quarter earnings results that meet or surpass market expectations. Young sees price-to-earnings valuations as a fairly efficient measure of stocks' true worth and says it's very rare that valuations get totally distorted, as they did during the tech bubble in the late 1990s.

Still, there's enough interest in beating the market to fuel the search for better valuation methodologies. Bloomberg BusinessWeek finds two fairly new approaches available to retail investors worthy of note.

The first tool is based on the concept of economic value added, or EVA, which Bennett Stewart created nearly 20 years ago as a way for companies to include the cost of capital in their profit forecasts when making business decisions.Stern Stewart & Co., a management consulting firm that Stewart co-founded in 1982, has long argued that EVA—calculated as the difference between net operating profit after taxes and the opportunity cost—is a better measure of shareholder value than earnings per share, which can be pumped up in the near term by investing too much capital for too low a return, or by cutting research and development spending, the basis for long-term growth.

Tool For Fidelity investors: PRVit

A stock rating system called PRVit—which stands for performance, risk, valuation investment technology and is pronounced "prove it"—uses the EVA methodology and has been available to institutional investors since 2005. In November 2009, EVA Dimensions, a Stern Stewart spin-off, licensed a retail version of PRVit to Fidelity Research Management, which added it to the stable of research tools that Fidelity makes available online to its customers. EVA Dimensions' licensing agreement with Fidelity isn't exclusive, but it has yet to arrange for distribution through other retail channels, says Stewart, the company's chief executive.

PRVit is a ratio calculated by subtracting a risk measure from a company's EVA and then dividing it by the stocks' current market valuation. The ratio is converted into a percentile index on a scale of 0 to 100 where the higher the number, the more desirable the stock is as an investment; the lower the number, the better the case for shorting the stock. Fidelity customers can enter the ticker of any stock in the Russell 3000 index, as well any of the 200 largest ADRs that trade on U.S. exchanges, and see the stock's PRVit score.