It's cork-popping time on Wall Street again. The Nasdaq is up 25% in the past six months to levels not seen since 2000, and many individual stocks are up by twice as much. That doesn't it's time to sell, but it surely means it's time to approach any fresh investments with a more cautious stance. Chasing high-multiple stocks right now makes little sense, in case we do indeed see profit-taking in the market.
This should point investors in the direction of low P/E stocks. These stocks could see solid upside if their forward multiple expands, and equally important, more limited downside if the market's mood changes (which, by the way, is exactly the approach I take in my $100,000 Real-Money Portfolio).
The good news: there are still a few dozen stocks in the S&P 500 that trade on the cheap. I've compiled a list of stocks trading for less than 10 times projected 2012 profits and less than 7.5 times projected 2013 profits. Some of these stocks are low-priced for a reason. For example, investors are still focused on the legacy problems at many U.S. banks, and 10 of them in the S&P 500 trade at very low multiples in relation to forward profits. If these banks can hit the mark and earn what they're supposed to, then their stocks may finally start a major upward move.
In a similar vein, a number of insurance stocks trade at low multiples. In this case, the dowdy valuations stem from a low-interest rate environment, which is squeezing their profit margins as investable assets score low returns. When interest rates eventually rise, so will their multiples.
You'll also find a cluster of energy-related stocks on the list of low P/E stocks. Flagging natural gas prices get some of the blame, especially for heavily-indebted names such as Chesapeake Energy (NYSE: CHK).
It's not clear why energy services firm Halliburton (NYSE: HAL), which also has exposure to the more robust oil industry, should be stuck with a low multiple. Merrill Lynch notes that the company's shares "continue to be priced for a collapse in North American activity and margins that are unlikely to materialize," and they see the stock rebounding from a recent $38 to $48.
Value opportunity or value trap?
To be sure, a low P/E may just mean that a stock is really more of a "value trap" than a value play. For example, video-game retailer GameStop (NYSE: GME) is likely on the wrong end of the secular industry trend away from disk and cartridge-based games, as I noted here.
For that matter, grocery chain Supervalu (NYSE: SVU) continues to underperform its peers and won't get a higher multiple until it can stem ongoing market share losses. And who knows if newspaper publisher Gannett (NYSE: GCI) will ever again be a growth stock.
Yet a host of other low P/E stocks in the S&P do look certifiably undervalued. Check out the names on this table.
Well, over the course of 2010 and 2011, the satellite TV provider generated a whopping $4.8 billion in free cash flow, and that's helping to quickly shrink the share count. Shares outstanding, which peaked at about1.39 billion in 2005, fell to 985 million in 2009, 880 million in 2010, 747 million in 2011, and should fall below 700 million this year. This represents a 40% reduction in share count in just seven years.
Yet it's the recent upward move in chip maker AMD (NYSE: AMD) that has caught my eye. I laid out a bullish case for AMD roughly a year ago, and though that was quite premature, shares now appear to be making a nice upward move. AMD's stock has risen from below $5 in October to a recent $7.40, and analysts at UBS see them rising to $11. They expect "a richer product mix to drive higher margins," echoing the comments I made back in January of last year.
Though AMD remains a distant second to industry leader Intel (Nasdaq: INTC), UBS sees market share rising from 5.9% in 2011 to 7% in 2012. They figure each percentage point of market share equates to another $0.08 in earnings per share (EPS). In fact, from a baseline of $0.51 a share in profits in 2011, UBS sees EPS hitting $0.89 this year and $1.32 by 2014. Not bad for a $7.40 stock.
Risks to Consider: These stocks remain inexpensive, because in many instances, they have failed to participate in the recent rally. That means they may remain out of favor if investors continue to seek riskier and pricier high-growth stocks.
Action to Take --> It's time to play defense, even as you play offense. These low P/E stocks will help you sleep better at night if the market starts to turn south because they are much more likely to retain their value.
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