No offense to them, but the bears are running out of excuses. Worse than that, the effort to pound the bearish table might be distracting them from some stunningly undervalued stocks that are bargain-priced — no matter what the market’s near-term destiny is.
We’ll look at those bargains, but first, let’s set the tone with a market valuation reality check.
The Arguments Are Falling By the Wayside
First, it was the assumption that the U.S. economy would be in a depression for years … perhaps forever. But by 2010, that 2008 assumption had been trumped.
Then, the pessimists argued that earnings growth wasn’t real growth, but accounting trickery. But after 11 consecutive quarters of sequential as well as year-over-year earnings growth (Q4 2011 is expected to be down), it’s tough to chalk up record levels of income as circumstantial.
Most recently, the naysayers are arguing that the market’s ultra-low trailing P/E ratio of 13.3 isn’t a reason to buy, since the P/E ratio doesn’t really matter.
Really? Since when does the P/E not matter?
The argument is as follows: Low P/E readings don’t inherently make stocks go up, and high P/E measures don’t inherently make stocks go down. Take the late 1990s. The S&P 500’s P/E moved from a tolerable 14.8 to a disturbingly high 29.6 by the middle of 1999, yet the market was rallying the whole time. Conversely, a multiyear-low P/E of 13.8 in the middle of 2008 didn’t stave off even more of a pullback for the broad market then. Fair enough, but time still managed to catch up with the market in both cases. The end of 1999 was the beginning of disaster, and the end of 2008 was the beginning of a recovery.
Point being, while a P/E ratio isn’t a laser-price timing tool, there is a measurable correlation between stocks and the market’s value. And yes, there is a semi-quantifiable “too high” and “too low” for the market’s P/E level. But there’s another aspect that needs to be added to the mix — the direction of the earnings trend at the time.
The Other Important Aspect
Click to EnlargeIt’s stupidly simple and painfully obvious, but it’s still overlooked. When earnings are rising, so is the market. When earnings are falling, so is the market. This was why the market tumbled in 2008 despite a low P/E reading — earnings were falling. And this is why stocks continued to soar in 1999 despite an already lofty valuation — earnings were on the rise.
See the difference? It’s the combination of the earnings trend and the P/E levels (along with some common sense) — and not just a P/E ratio alone — that allows investors to make an informed judgment call on the foreseeable future for stocks.
Fast-forward to today. Earnings are on the rise and reasonably expected to keep rising through 2012 — and the market is as undervalued as it has been since the late ’80s.
Now, about those crazy stock bargains …
For the same reason the combo of earnings growth and valuation was key to handicapping the market, individual stocks also reflect this dual set of criteria. Here are three names that also are ultra-cheap right now, yet shouldn’t be, considering their growth trends.
Click to Enlarge The video game publishing and software industry has been struggling for a while, and retailers have been unfairly lumped into that demise. The fact is, video game retailer and reseller GameStop (NYSE:GME) is generating record earnings, and has fostered very reliable earnings growth for a decade.
The stock has not reflected that earnings strength, though. Indeed, GME shares were punished — unfairly — in 2008, and for some reason they never recovered with the market, even though GameStop’s bottom line growth was far better than average. The end result is a trailing P/E of 8.5. The good/urgent news: The chart is starting to perk up now that investors are catching on.
Click to EnlargeMicrosoft (NASDAQ:MSFT) certainly has its critics, but investors aren’t part of that group. Earnings barely blipped in 2008, then resumed their smooth growth rend in 2009. The last 12 months’ earnings have also been the best 12 ever for Microsoft, netting $2.75 per share.
Like GameStop, though, investors made pessimistic assumptions about the company’s future (lack of smartphone presence, dying PC business, software becoming passé in the new cloud environment) and were wishy-washy at best with the stock. Now MSFT shares are priced at a measly 10.3 times earnings, and the company is better positioned for earnings growth now than it has been in years.
Click to Enlarge Though L-3 Communications (NYSE:LLL) might not be ready to revisit its earnings levels from the heydays of 2006 and 2007, L-3 has been cranking out continued earnings growth since 2008. Shares have been on the wrong side of the table most of the time, though, having hit a multiyear low around $58 in September.
While L-3 is back up to $70 in the meantime, the trailing P/E of 8.05 still is rock-bottom. The pros currently are looking for L-3 Communications’ earnings to slide from $8.72 for 2011 to $8.49 in 2012, but after four straight earnings beats, it’s pretty clear 2012’s estimates are in dire need of an update.
These are just a few of the possibilities. While the media and the loudest pundits are trying to paint bearish pictures, they’re overlooking some amazing values. Go shopping.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.