Some of the best minds in the business believe that stocks are fairly and fully valued today.
Warren Buffett was the first making the pronouncement. The Oracle of Omaha known for his value style of investing isn’t seeing many buying opportunities at the moment. Next up is famed hedge fund manager Julian Robertson. He too sees a market at full price with little room for improvement.
Then there is little report from Societe General (SCGLY); it says the market is likely to plunge in early 2014. Citing market prices that have reached a peak with nowhere to go but down, the bank says that Federal Reserve tapering will be the trigger for 15% move lower.
I suppose we should just throw in the towel and pack it in until things change.
Wait! Time to Go Micro
No hold on just a minute. These proclamations from some impressive sources may be scary and all, but they are macro in scope.
That means there are several micro stories that can do well irrespective of what happens with the rest of the market.
For example at the end of August, I found a little stock called INSYS Therapeutics (INSY) The company showed up as a top-rated stock using a stock-rating system based on something I call the P/E Gap – the difference between a stock’s P/E ratio and its expected profit growth rate.
Since Sept. 1, INSY is up 78% as of early trading on Oct. 8. Those are huge gains and gains that can still be found in a market that is supposedly fully valued.
The PE Gap approach works because it identifies micro opportunities based on pricing inefficiencies. These pricing inefficiencies ultimately get corrected with the end result on the long side being significant gains.
Here are three stocks that are highly rated according to my P/E Gap approach ready to zoom higher in a fully valued market, and would make Warren Buffett sit up and take some notice:
Even if you assume that the market is fairly valued, there are certain industries that project very well over the coming 12 months. One space in particular to watch is the film and movie industry. As the consumer gains more confidence, movie-going will see strong and growing sales that can propel stocks in that group higher.
Specifically, companies in the animation space can seem to do no wrong. Put up a family-friendly animated film and you have the chance for a blockbuster. There are risks of course, but the formula is tried and true. That bodes well for DreamWorks (DWA) The company rated highly at the end of September using the P/E Gap approach. Analysts expect the company to grow profits next year by more than 40%. With shares trading for just 30 times 2014 estimated earnings, look for the stock to rally from current prices even in a fairly valued market environment.
With interest rates remaining at historically low levels, look for the homebuilder industry to continue to put up strong numbers in coming quarters. Yes, stocks in the group have rallied, but the market put the brakes on this summer under the threat of higher mortgage rates.
Shares of Ryland (RYL) peaked at $50.42 per share. After a sharp correction, you can now buy the stock for under $40 per share. In other words, the expected macro correction has already happened here. At the same time, earnings numbers keep on surprising in a positive way. Ryland has crushed estimates in each of the last four quarters. With shares trading for 10 times 2014 estimated earnings, the stock is a bargain. I wouldn’t worry about a fully valued market here until the earnings multiple expands greatly.
The airline industry is a good example of where the micro trumps the macro. Stocks may be fully valued in general, but that has little to no impact on the leverage no being generated by airline companies. Planes are full, fees are rocketing higher, and there is less competition. The story just keeps getting better and while stocks in the airline industry have appreciated greatly there is more meat on the bone.
Case in point is United Continental (UAL). Analysts expect the company to grow profits by 66% in 2014. At current prices shares trade for seven times 2014 estimated earnings. Now that’s a bargain Warren Buffett would find attractive. You should too, no matter the current valuation of the overall market