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Nobody likes to see daily
bloodletting in the market. But look on the bright side.
While these downturns can be frightening, think how
different investing would be without them. In a perfectly
efficient market, we could never buy a stock at a discount,
or sell one at a premium -- every security would be
perfectly priced, all the time.
It's only through irrational, emotion-driven selling that
value investors occasionally get the chance to pick up a $50
stock for just $25 per share, or possibly even less.
Value investors like myself are the
bargain hunters of the investment world. And when
the market is booming and nobody wants to part with their
stocks, our job can be tough. But when bearish sentiment
reaches a crescendo and investors can't exit their positions
fast enough, shopping is good.
Unfortunately, these rare buying opportunities only come
around once or twice a decade.
The last time the entire market traded at such drastically
marked-down prices was back in 2002. As you may recall,
stocks went into recovery mode shortly thereafter and
rebounded almost +30% over the next 12 months. Few would
turn their nose up at that type of gain today. But that was
just the broader market -- a number of sharply underpriced
stocks could have netted you gains ten times that size.
As
fear flooded the market and corrupted rational decision
making, downtrodden investors were
willing to sell you quality companies like Research In
Motion (Nasdaq: RIMM) for a split-adjusted $5 per share or
Apple (Nasdaq: AAPL) for just $12 per share.
Forward-looking investors who took advantage of the rampant
pessimism have since been rewarded with massive gains of
more than +1,200% for RIMM and more than +750% for AAPL. And those are hardly isolated
examples.
Don't Let Fear Make You Miss the Rebound
That's why long-term investors should be
cheering this irrational dumping of quality stocks.
If you walked into a retail outlet like Best Buy or Target
and found row after row of brand-name merchandise marked down
-40% or more, you would probably load up the shopping cart.
However, though it may seem counterintuitive, investors
aren't wired quite the same way and tend to fear massive
stock declines rather than embrace them for what they really
are -- golden windows of opportunity.
During turbulent times when the market is in freefall and
the economy is foundering, it's all too easy to fall prey to
doomsday thinking and throw in the towel. However, this is
the time to remain cool and calm -- and pounce on those
unloved stocks at wholesale prices.
At this point, the whole market is undervalued and poised
for a rebound once confidence returns. But just as we saw in
2002, you can bet that some stock will undoubtedly emerge as
market leaders and sprint far ahead of the pack. To pinpoint
these future winners, there are three time-tested strategies
that value investors can use.
Strategy #1 -- Astonishing Value Plays
Price/earnings ratios can be fairly blunt instruments.
However, they do give us a pretty good idea of what
investors are typically willing to pay for a company
relative to every dollar of earnings it generates. And they
can also serve as a broad indicator of whether a stock, a
specific sector, or even an entire country is undervalued or
overvalued.
Of course, some industries traditionally
trade at relatively low earnings multiples even in good
times, so they might not be as cheap as they seem at first
glance. Therefore, it's usually a good idea to compare a
stock's P/E to that of its peer group and its own
historical average. If a quality company with an undamaged
outlook typically commands 20 times earnings but is suddenly
getting only 10, then you may have a viable prospect.
The last time
the S&P 500
P/E ratio
was this low, stocks promptly took off
on a multi-year tear. |
Over the last 20 years, the S&P 500 has
traded at
an average P/E of 23.3. Now it trades at 14 times earnings. 222 of the 500
holdings have P/Es below
10. And 478 of the 500 are trading below their 20-year
average multiple. The last time P/E multiples fell this low
was in 1997. You can
see what happened next -- stocks enjoyed a multi-year rally
and rocketed to new highs.
Strategy #2 -- Cheap Growth Plays
As you can see, P/E ratios are useful in identifying
severely underpriced stocks that may be poised for a
dramatic recovery. However, like any metric, they don't tell
the whole story. After all, they say nothing about a
company's future growth potential. Two stocks trading at
identical P/E ratios might seem to be equally
valued. But what if the first company was expected to
deliver earnings growth of +10% annually and the second was
projected to boost its bottom line by +20% per year?
All things being equal, you would clearly prefer the second
company.
Companies that may seem expensive on the surface are
actually undervalued once their future growth potential is
factored in. So investors that automatically dismiss stocks
with seemingly high P/Es could be missing out on some of the
market's most extraordinary opportunities.
I've found 146 stocks selling for
earnings multiples below 10 that are projected to grow more
than +25% next year. Legendary money manager Peter Lynch
once said that when you find a 25% grower trading at just 20
times earnings, it's time to "back up the truck." So can you
imagine the potential gains waiting for investors that can
find the same promising company trading at a rock-bottom P/E
of 4?
I've found a liquor distributor in exactly this situation
right now. Once this stock regains its normal P/E of 22.6
that it averaged for the past 10 years, you could be sitting
on $5.70 for every $1 you invest now -- and that's assuming
the company doesn't increase its profits by a single penny.
Strategy #3 -- Fat Dividend Plays
There is another
silver lining to the market's precipitous plunge: dividend
yields are at historic highs. You don't always get this gift
when stocks drop. When the tech bubble popped yields rose a
bit, but that was nothing compared to what we are seeing
today.
There are scads of double-digit yielders out there. For
example, dull oil pipeline operators that typically yield 5%
to 7% in normal times now sport enticing yields of 12%.
These rich yields don't last for long. When the market
returns to normal, payouts could well slide back to 6% --
but for investors who act today, you will have doubled your
money by that point. Better still, if that same pipeline
operator increases its dividends over the next few years (as
most do), you could soon be earning 15%, 18%... even 20% or
more on your initial investment.
Aberdeen Australia Equity
Fund (AMEX: IAF) saw its yield spike up in August 2007. Investors who
bought to capture the yield of
11% saw their shares jump
from $12.50 to $17.50 in less than two months.
This just goes to show how
quickly these high yields can disappear if you
don't act to lock them in.
Now Is the Time to Get In
There are two ways to look at this tumultuous year-long
sell-off in the market: It's either a frightening nightmare
or a golden window of opportunity.
Yes, most of the ticker symbols you follow (or own) are down
alarmingly from their peaks. But as Warren Buffett astutely
reminds us, successful investors don't rent stocks -- they
own businesses. And right now, many of the world's most
powerful companies can be purchased at levels and with
yields that haven't
been seen in decades.
We even found one shipping company that enjoyed a stable 8%
yield for years -- until this market discounted its price
tag. Now you can get the same stock with a yield closer to
20% -- thanks to its lowered price and the fact that it
raised its dividend distributions every quarter in 2008.
Thanks to the
market's manic-depressive mood swings, you can take
advantage of this clearance sale and make your investment
dollars work harder. But as investors come to their senses,
these deals will disappear. To discover what we're doing and
learn more about some of our favorite new ideas, just
follow this link.
Good investing!
-- Nathan Slaughter
Editor
Half-Priced Stocks
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