This Metric Says Stocks are Dirt Cheap Right Now

James Brumley's picture

Wednesday, August 24, 2011 - 1:00pm

by James Brumley

I've been in the investing business a long time. I've witnessed two nasty bear markets and three bull markets, including the massive one from the 1990s. I've seen a technology boom then bust, a collapse of the mortgage market, an outright currency war, and the total evolution of the Internet. As a broker, trading analyst and financial journalist, I've seen, heard, and done it all (most if it more than once). At this point in my career, I never expected to see anything I hadn't seen already.

Well, I was wrong.

Though not for the first time in my life, for the first time in my adult/investing life, I'm seeing a market that's as undervalued -- on a trailing earnings basis -- as it's been in 20 years.

I know my "glass half full" point of view puts me in the minority. Most analysts and commentators are working hard to convince investors that stocks are doomed because we're headed back into a recession. And, I understand their arguments. I just don't agree with them, for a couple of reasons.

Uncharted value
Most of the time, most stocks are trading in the middle of their lifetime averages. Whether you're talking about price-to-earnings (P/E) ratios, net profit margins or earnings growth, the majority of stocks usually just look nominal. When we start to see values and ratios we've never seen before though, this is usually the root of a huge opportunity, or a massive disaster. You just have to be willing to recognize it.

Case in point: Nobody seemed to care back in the middle of 1999 that the S&P 500 was priced at a record 29 times trailing earnings. But, less than a year later, this excessive value came back to haunt those folks who jumped into the tech bubble right before it burst.

Now the fear/greed pendulum has swung too far in the other direction. As of the last look, the S&P 500 is priced at 12.3 times its trailing 12-month earnings, which is as "cheap" as the market has been since the late 1980s.

It's not just the market as a whole that's priced at a record-low value right now. Wal-Mart (NYSE: WMT) shares are at a multi-decade-low trailing 12-month P/E of 12.1, yet its bottom line has recently reached record-breaking levels. Microsoft (Nasdaq: MSFT) is on the verge of reaching a modern-era low P/E of 8.6, yet like Wal-Mart, just posted record-breaking 12-month earnings (trumping the theory that Microsoft is a has-been). Even Campbell's Soup (NYSE: CPB) -- one of the most defensive, recession-proof names out there -- is now trading at its lowest P/E measure in more than a decade. The stock's priced at 12.4 times trailing 12-month earnings, even though (you guessed it) Campbell's Soup recently reached record-breaking earnings levels.

And it's the demise of Campbell's Soup shares that really leads to me to conclude that the collective market is simply overreacting to a little bad economic news, selling anything and everything in sight regardless of any value, perceived or otherwise.

This possibility sets up reason No. 2 I'm actually a bull rather than a bear.

More talk than substance
It would be naive to think the economy is "fine." It isn't great, right now anyway. Conversely, it would be short-sighted to assume we're back in a recession, as there's no actual evidence of economic contraction yet. While growth may be slow (and even slowing), it's still growth.

Now, if you disagree and see the economy already on the slide, I'm not going to try and talk you out of that today. Let's just agree to disagree so we can continue the dialogue. I will ask you one not-so-hypothetical question just to get you thinking though: Is it at least possible the surprising onset of the recessions in 2000 and 2007 might be causing an instinctual, reflexive response to even the slightest hint of trouble now?

I'm just saying...

But what about the terrifying prospects being batted around on financial news television? The majority of those experts are more than a little pessimistic on stocks right now.

I'll let you in on a little secret -- networks love to trumpet those disaster-oriented themes because fear draws a crowd, and increases ratings. Take a closer look at Nouriel Roubini's and Robert Prechter's outlooks and comments from early 2009 and even as far back as 2003. They were bears then, too, right in front of major bullish events. These gloom-and-doomers are just given a bigger platform when it feels like they might be right. [See: "How to Avoid the Worst Investing Mistake I've Ever Seen"] This well-voiced pessimism can quickly become investors' adopted reality, even if it's not the market's ultimate outcome.

Action to Take -->
There's an old Wall Street adage: "Economists have predicted nine of the last five recessions." It's funny because it's true. All of the errant predictions seem to make perfect sense at the time.

Now take a step back and really absorb how the overall market and many individual stocks are literally cheaper than they've been in more than a decade. When you start seeing once-in-an-era low valuations while earnings are still on the rise, then you have to work through the fear and be willing to do what most others aren't. Campbell's Soup, Wal-Mart, and Microsoft would all be great places to start that journey, with Wal-Mart at the top of that list.

P.S. -- If you devote a portion of your portfolio to "swing for the fences" plays, you should watch this video. It shows how six shocking events could lead to hundreds of percent gains for prepared investors.

James Brumley does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.