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Don’t Pay Top Dollar in This Disconnected Market

Look for stocks that the market is underestimating


Hope springs eternal … at least on Wall Street.

First-time jobless claims ticked up by 7,000 in Thursday’s weekly release from the Labor Department, and homebuilder stocks tanked as PulteGroup (PHM), a major industry player, reported a 12% drop in new-home orders versus a year ago. But the headline stock indices chugged higher anyway.

It’s more of what we’ve seen for the past 52 months now: Statistics point to the weakest economic recovery on record, yet the stock market keeps climbing, and climbing.

On one level, the disconnect is understandable. Publicly traded corporations, in the aggregate, are churning out record profits. That in itself would justify a good part of the more than 100% gain the S&P 500 has posted since the March 2009 bottom.

However, it’s also worth asking how those profits came about. To some extent, we can credit the free-enterprise system. In recent years, corporate managements in the United States have done a spectacular job of squeezing out costs.

At the same time, we know there have been some artificial factors at work. Massive government spending on welfare benefits has supported consumer spending and bolstered corporate revenues.

In addition, the Federal Reserve’s zero-interest-rate policy has suppressed corporate borrowing costs. Economist David Rosenberg estimates that about 30% of today’s big-company profits trace back to government “help.”

It doesn’t necessarily follow that once Uncle Sam’s largesse goes away, profits will collapse. All along, businesses and households have been saving and investing. Real wealth is being created.

Almost certainly, though, the Fed’s easy-money policy has spurred businesses to undertake some projects that will ultimately fail when interest rates return to normal levels. That’s why I’m reluctant to pay top dollar for stocks in today’s environment. If government policy has caused current profits to be even moderately overstated, share prices will likely undergo a significant “correction” sometime in the next 12-24 months.

So the hunt goes on for companies whose earning power has been underestimated (not the reverse). They’re precious few in number these days, but we keep looking.

Qualcomm (QCOM) is one that I’ve found for my subscribers. Earlier this week, the Street was fretting that QCOM might deliver a wet blanket of an earnings report.

Instead, the maker of cellphone chips met analyst projections Wednesday and actually raised its guidance slightly for the fiscal year. The stock jumped 3.3% Thursday. I’m looking for a total return of close to 20% in the year ahead.

Richard Band’s Profitable Investing advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk value approach has won seven Best Financial Advisory awards from the Newsletter and Electronic Publishers Foundation.

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