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Here's a New Way to Value S&P 500 Stocks

January 22, 2024
minute read

Investing and trading represent distinct activities within the financial realm. The stock market often captures the attention of media, focusing extensively on the short-term dynamics of traders striving to secure optimal buy or sell prices. In contrast, long-term investors engaged in selecting individual stocks must delve into the fundamental quality of the companies constituting their portfolios.

The success of a long-term investing strategy unfolds gradually over many years. For instance, the SPDR S&P 500 ETF Trust demonstrated a 26.2% return in 2023, inclusive of reinvested dividends. However, this followed an 18.2% decline in 2022. As of the latest update, the fund yielded a 4.8% return since the close of 2021. Over the preceding decade, the SPY exhibited a noteworthy 215% return, indicating a compound annual return of 12.3%, according to data.

While broad market indices may exhibit favorable long-term performance, the assessment becomes more nuanced when evaluating individual stocks. Recently, Mark Phillips of Ned Davis Research compiled a list of 31 "wonderful European companies at a fair price" based on a decade's worth of return on assets and other metrics. Refining this selection, we narrowed it down to 10 stocks by considering anticipated increases in earnings per share through 2025.

Applying Ned Davis Research's methodology to the U.S. market involved scrutinizing the S&P 500. The screening process included a thorough examination of 10 years of returns on assets, as calculated by FactSet. From 468 S&P 500 companies with a decade of earnings history, 262 exhibited a 10-year average return on assets (ROA) of at least 5%. Additionally, 216 companies maintained positive ROAs for all 10 four-quarter periods, while 123 displayed a two-year average ROA surpassing their 10-year average.

The historical screening process extended to companies' earnings yields over the past three 12-month periods. Earnings yield, derived by dividing trailing earnings per share by the current share price, was scrutinized to identify companies trading at a perceived fair price. The subsequent analysis revealed that 55 S&P 500 companies exhibited relative earnings yields above their three-year averages.

To further refine the list, consensus earnings estimates through 2025 among analysts polled by FactSet were considered. The resulting 20 companies, meeting the aforementioned criteria and demonstrating the highest expected compound annual growth rates for earnings per share through 2025, constituted the final selection.

When opting for individual stocks over lower-risk index funds or actively managed funds, it becomes imperative to independently assess a company's capacity to maintain competitiveness in delivering goods or services over the long term. Initiate your research by exploring the provided tickers.

Drawing parallels with Phillips' screening process for European companies, those passing the screen for the S&P 500 tended to outperform the broader equity market. In the case of the 20 selected companies, each boasted 10-year total returns surpassing the index's 10-year return of 218% through the latest available data.

Notably, Nvidia Corp. emerged as the leader with the highest expected earnings per share compound annual growth rate through 2025. However, it also stood out as the most expensive stock in the list by screening criteria, attributed to its low earnings yield. The premium associated with Nvidia can be attributed to its consistent return on assets performance and rapid growth trajectory.

Adan Harris
Managing Editor
Eric Ng
John Liu
Editorial Board
Bryan Curtis
Adan Harris
Managing Editor
Cathy Hills
Associate Editor

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