Markets & Finance

Stocks: Seven Brainy Bargains


S&P's latest screen combines analyst insight and sophisticated computer models to ferret out names with big upside

From Standard & Poor's Equity ResearchStocks have taken wing this spring, and many investors may be asking whether they've gained a bit too much altitude. As of Apr. 25, 2007, the Standard & Poor's 500-stock index had posted a year-to-date gain of 5.4%, to 1,495.41. At this level, the S&P 500 is less than 2% shy of Standard & Poor's Investment Policy Committee's 2007 yearend target of 1,510. The S&P MidCap 400 has shown an even greater return year-to-date, rising 10.4%.

Given the lofty heights for equities, we asked ourselves, "Where can investors still find value?" We took a two-pronged approach with this week's screen, searching the universe of stocks covered by S&P using the insights of S&P's equity analysts and the number-crunching clout of its proprietary computer models.

The first measure we turned to was fundamental 12-month target price, as projected by S&P equity analysts. Our analysts assign this target to the stocks they follow, based principally on a blend of the values that are derived from the following three analytical, "bottom-up" approaches:

Intrinsic value is based on resources such as S&P's discounted free cash flow and other quantitative tools.

Relative valuation compares a stock's valuation to that of its peers and the broader market.

Sum of the parts calculates the private market value, based on a prospective breakup of the company.

We looked for those issues trading 20% below their 12-month price targets, which implies considerable upside.

Then we turned to a "black box"—S&P's Fair Value model—for our second and final filter. 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. Under the model, the stocks are assigned a fair value, the price at which they should trade based on the model's calculations.

Once again, we looked for stocks trading 20% below their indicated Fair Value.

When we finished the screen, seven names turned up, including some tech and energy names. We spotlight S&P analyst views on three of them:

Best Buy: The electronics retailer's shares trade at a price-to-earnings (p-e) multiple below its industry peers and in line with the broader market, notes analyst Michael Souers, despite sporting greater growth potential and what he considers to be a stronger balance sheet (see BusinessWeek.com, 4/23/07, "Why Best Buy Is a Best Bet").

Chesapeake Energy: Analyst Tina Vital views this independent energy producer's growth strategy as aggressive, with acquisition spending totaling more than $10 billion over the past three years.

Western Digital: Jawahar Hingorani, who follows this technology company for S&P, believes it will continue to see growth in its 2.5-inch disk-drive business, seasonality notwithstanding, and is also encouraged by its cash generation and what S&P views as a healthy balance sheet.

Company

S&P Analyst Target Price

Best Buy (BBY)

$63

Chesapeake Energy (CHK)

$44

E*Trade Financial (ETFC)

$27

Flextronics International (FLEX)

$14

Superior Energy Services (SPN)

$45

Western Digital (WDC)

$23

Weatherford International (WFT)

$64

Kaye, an analyst for Standard Poor's Portfolio Services, is the author of The Standard Poor's Guide to Selecting Stocks.

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