The Applied Finance Group's Value Expectations interface sets out to understand the imbedded sales growth a company or index needs to earn over the next 5 years to justify an index or company's current price. The chart below gives a look into the Implied Sales Growth priced in to the S&P 500 over the next 5 years. Currently the implied sales growth over the next 5 years is 3.49%.

You can see that back in May 2001, investors were too optimistic in their willingness to pay for the average company in the S&P 500 to generate sales growth of over 17.5% for five years.   Conversely, we can see how stocks went “on sale” in November of 2008.  Investors could buy stocks that were priced to shrink sales by 8% for five years and still be fairly priced.  

Today we can see that investors have regained some confidence by paying for an implied sales growth of 3.5% for the average company in the S&P 500.   This positive sentiment was confirmed by AFG’s Market Forecast Project and the recent market rally we have all missed.

I would like to mention that when we solve for sales growth, we use AFG’s Economic Margin Framework to correct for accounting distortions by taking into account Asset Life, Asset Mix, Asset Age, Capital Structure and Growth, Cost of Capital and Inflation.  In the near future, we will be issuing articles that go into further detail on how we use the Economic Margin as a valuation system. 

Since the stability of the market is still very much in question, the key for investors will be to identify companies those companies that still have low “value expectations” embedded into their stock prices. We will continue to issue articles to identify some of these companies with low expectations and steer you clear of value traps.