You will notice in the chart below that the Energy, Financial and Health Care sectors seem to be dragging down the returns of the overall index, while the Consumer Discretionary and Industrial sectors are leading the way.
Now that we have an understanding of how each sector has performed thus far in 2010 we would like to understand the expectations that are priced in for each sector to see which sectors look the most likely to outperform going forward.
The Applied Finance Group's (AFG's) Value Expectations (VE) interface provides clients a platform to better understand economic profitability, and at the same time understand the performance a company must deliver to justify its current stock price. By understanding the embedded expectations a company must deliver to justify their current trading price, clients can develop a "hurdle rate"? to quickly determine if the company's expectations are rich or low.
When using the VE interface to solve for the implied sales growth for every company within the S&P500, we found that the average implied sales growth for the overall index is 14%. This is more than the S&P500's 5-year median for sales growth of 10% as well as the consensus average of 12%, which would suggest the index is still slightly overvalued. The chart below displays this comparison, as well as the implied sales growth, historical sales growth and consensus sales growth estimates for each AFG defined sector within the index.
Our results indicate that the Energy and Health sectors have the largest spread between imbedded sales growth expectations and the 5 year median sales growth that they have achieved, which would suggest these sectors have relatively low implied sales growth expectations. Given the roller coaster ride that the Health Care sector has been on the past year, it is reasonable to think that the market has very low expectations, the question the money manager has to ask themselves is whether or not they can deliver above those expectations. If you look at the average consensus sales growth estimate for the Health Care sector, you will find that the consensus is that they can deliver 11.6% revenue growth. On the other end of the spectrum, the Utilities and Basic Material sectors seem to have the loftiest sales growth expectations embedded in their current stock price.
Along with this breakdown, after identifying interesting sectors to explore or avoid, it is only fitting that we also provide a few attractive companies using our Economic Margin framework. The companies we have provided in the chart below have been identified as the companies from within the Health Care sector that look most likely to outperform their sector peers based on key criteria used in The Applied Finance Group's stock selection process, such as valuation attractiveness and economic profitability (Economic Margins).
AFG's research and suite of investment tools help investors to easily understand a company's true economic profitability, as well as if the company's asset management policy is suitable to maximize that profitability. AFG's Wealth Creation Report allows you to visually analyze a company's historical Economic Margin level, current EM and expected change in EM based on projections built out by AFG's default valuation model, which takes into account the total cash flow a company delivers. A company that earns above its cost of capital (positive Economic Margins) and is growing its asset base is considered to be following a wealth-creating strategy. Back-tests have proven these companies to be more likely to outperform those companies following a wealth-destroying strategy (negative Economic Margins and growing assets).
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Beyond having positive Economic Margins and growing assets, investors want to see a company improve its EMs at a greater rate than its sector peers, as these companies have also proven to be more likely to outperform than companies with declining EMs.
Below is an example of a company AFG considers to be a consistent wealth creator, identified by using AFG's Wealth Creation Report.
Cerner Corp. (NASDAQ:CERN) "â?? A Consistent Wealth Creator
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Value Expectations, by the founders of The Applied Finance Group (AFG) provides institutional quality equity research using AFG's proprietary Economic Margin framework
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