It seems that authentic bargain stocks are once again becoming an endangered species. Two weeks ago, when the blue-chip market indexes hit bottom for this recent “correction,” we had a pretty good menu of cheap stocks and mutual funds to choose from. But the Dow’s wicked 666-point rally since then has sharply narrowed the buy list.
Lest you think I may be sifting with too fine a screen, I should add that I’m not alone in my complaint. On Friday, Ben Inker, the well-regarded asset-allocation specialist at GMO in Boston (a money-management firm with $107 billion under its wing) gave a sobering talk at an investment conference sponsored by Babson College.
According to Inker’s calculations, the market as a whole would have to drop 29% to bring it back to fair value. He estimates fair value by using a formula that incorporates 10 years’ worth of earnings and a desired “real” (inflation-adjusted) return of 5.7%.
At current levels, Inker says, the market is priced to deliver only a 3.8% annualized real return — including dividends and capital appreciation — over the next seven years.
If the broad market is overvalued, as Inker and others (such as Yale Professor Robert Shiller) argue, it follows that relatively few investments will pass muster as cheap stocks to buy at today’s prices.
There’s a silver lining in this cloud, though: A select group of very high-quality companies continue to be unusually cheap. I’m referring to cheap stocks such as:
- Bank of New York Mellon (NYSE: BK) — Buy below $31
- Johnson & Johnson (NYSE: JNJ) — Buy below $62.50
- Microsoft (NASDAQ: MSFT) — Buy below $28
- Procter & Gamble (NYSE: PG) — Buy below $64
Over the next 12 months, I project that an equal-dollar package of these four will generate a total return of 15%-25%. And over the next decade, I’m confident this quartet will leave the major market indexes behind in a cloud of dust.