Create a List of Stocks for Evaluation

In my last post, I focused on the companies that were likely to have the most sustainable competitive advantage by sorting a list of my favorite companies by return on equity. In this post, I will apply a few simple calculations to see which companies are likely to offer the best value and then create a short list for further analysis.

The calculated fields that I have added to my list include the 52-week low price to earnings ratio (P/E), the 52-week high P/E ratio, the current P/E ratio, the full price, and the current percent of full value. The price to earnings ratio is a fairly typical valuation metric. It’s quick, it’s easy, and it can be a little misleading at times. However, it’s a nice place to start.

One thing worth noting is the wide range between the 52-week lows and the 52-week highs and their respective P/E ratios. Does it really make sense that the range of prices for a company like Starbucks would range between $42 and $64 in a year with the respective P/E ratio fluctuating between 24 and 36? Disney is a fairly stable company, but it has traded between $86 and and $120 per share. As investors, we hope to exploit these opportunities to sell when the market misprices a stock on the high side and buy when there is a mispricing on the low side.

P/E ratios are fairly easy to understand, but I should probably explain what I mean by full price. Typically when I develop a valuation of a company, it ends up landing at two times the earnings growth rate. For example, a full valuation of Starbucks will likely land at two times their earnings growth rate of 18.7%. Two times this rate (and times 100) is 37.4. At a full valuation, Starbucks would trade at 37.4 times earnings, which would put the price at $66.57 per share. A lot of work has to be done to determine if Starbucks can really grow at 18.7%, but analysts are projecting growth in this range, and for now we are just looking to build a list for future research. Below is my list of companies sorted by the greatest discount to full price.

There are likely some anomalies here. The most obvious is Southwest Airlines. I don’t know that it will ever trade at 28 times earnings, especially at the market top. This is a cyclical company that would only likely trade at this strong of a P/E ratio at a market bottom with anticipation for a recovery. Now is not the time.

I tend to favor companies that have better earnings growth prospects. I am looking at Skechers appearing at the top of the list, and Marriott and TD Ameritrade surprise me as well. There are some strong companies trading at decent discounts.

The Short List

In creating my short list of stocks for further research, I want to take a close look at companies with high returns on equity that also are trading at a discount to what could be considered a full price. I am definitely interested in every company on the list that has favorable long-term growth prospects that also produces high returns on equity, but for now I want to prioritize them based on their valuation and work my way down the list.

Below is my unscientific list for further research. It contains the fields of return on equity, 5-year projected growth, and potential discount to full price.

I kept Southwest Airlines on here, though it probably won’t be the first one I look at. Skechers really jumps out at me, with the potential to be 37% of their full price. I’m really focused on the companies with double digit earnings growth and strong returns on equity. TD Ameritrade will also get my attention, though I have not taken a close look at their industry. Disney, Starbucks, and Google (Alphabet) are all solid companies. Marriott also surprises me and may be fairly easy to understand. I know they are in the midst of a very big acquisition that may be holding down their share price.

I look forward to digging in to some of these companies to determine what they are worth and if they will make good investments.

Disclosure: I already hold many of the stocks mentioned in this post.

3 Comments

  1. Hi Dan,
    You have a short list of 15 stocks that are pretty common names, and mostly large cap. Was this by design? Also, I see heavy saturation of companies in the Sectors of Consumer Discretionary & Consumer Staples. No love for Industrials or energy? Out of your list of 15, I like Mastercard & Alphabet. Crowded trades include: Amazon, Apple, Berkshire, Disney & Southwest, however I would never bash on Disney, never!

  2. Thanks for the comment. My short list of stocks for evaluation is the result of me picking companies that I would interact with. I work in finance, so I know enough to fear banks. Insurance companies also face some serious headwinds. So while the weighting is toward consumer discretionary companies, this is mostly a result of me focusing on businesses that I understand first. Maybe a little bit of a bias, because I have an idea of where I’m headed with this.

    I’m looking for businesses that are easy to understand, have strong competitive advantages with strong management that can be purchased at a discount to what they are worth.

    I’m really interested in the companies with monstrous returns on equity and those with super big discounts. I’m working my way through Skechers and hope to have something up soon. I can’t wait to dig in to Starbucks, Nike, Mastercard, and Disney. I find Marriott really intriguing as well and I might have some expertise there that others may not. My competitive advantage.

    My guess is that we have some great companies at fair prices for the most part. I really want to pin down the values, and I also suspect that the best course of action after I pin down a value will be to wait for an even better price. Nothing wrong with cash as all the U.S. indices are near all-time highs. It is very likely that not much is on sale (also why I’m starting with Skechers).

  3. Pingback: Skechers Analysis and Valuation – Investing Odyssey

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