The Fed Is Telling You to Buy Stocks

OK, so Ben Bernanke hasn't actually taken to the airwaves and said, "Hey, you -- yeah, you -- buy stocks!" But the actions that he and the rest of the Federal Reserve board members have taken shout that exact sentiment.

Investors are always looking for the best place to stash their money, both to keep their principal safe and to earn decent returns. By slashing the Federal Funds Rate to a ridiculously low range of 0% to 0.25%, Bernanke's been making sure that low-risk parking spots like cash and government debt are as unattractive as possible.

And the ploy has worked. Holders of cash now have to worry about the potential for loose monetary policy to lead to value-destroying inflation, while Treasury investors have to concern themselves with the same as they collect their meager 0.03% on three-month Treasuries and 3.4% on 10-year notes.

Risky stocks still look attractive
There are many ways to define risk in investing, but for me, one of the major ones is paying too high a price for a stock.

A high valuation typically requires that a stock post major growth in order to produce an acceptable return on your investment. So either the stock grows like a late-career Barry Bonds or you're stuck with mediocre returns (if not losses).

But in this low-interest-rate environment, which encourages investors to increase their allocation to stocks, higher valuations with or without the prospect for torrid growth can still look attractive. If we flip the standard price-to-earnings ratio on its head to look at the current earnings yield of many companies, we can see that even with higher price tags, they still beat the no-growth alternatives like cash and bonds.

Source: Capital IQ, a division of Standard & Poor's.

Happy endings are just stories that haven't finished yet
It's nothing short of crazy, though, to think that this situation will persist. Right now the Fed seems to think these nutso interest rates will help, as though monetary policy can be used like a defibrillator on the economy. As soon as the patient starts showing real signs of life, there's a virtual guarantee that the Fed will pull up the paddles.

How will the valuations above look once 10-year Treasuries climb over 4% (which we last saw in 2008), or breach the 5% mark? If you said, "Much less attractive," then give yourself a gold star.

What you should be doing
While the Fed is trying to make pretty much all stocks (and other risky assets) look attractive by making alternatives decidedly unappealing, our task as investors is to find stocks that are attractive on a longer-term basis.

Considering the 60%-plus jump in the S&P 500 index over the past nine months, our task is more difficult than it was just a few months ago, but there are still plenty of quality stocks out there trading at very reasonable prices.

To combat the Fed's full-court press to try and get us to buy stocks, I've been focusing my time on what I believe is one of the most underappreciated aspects of stocks -- namely, dividends.

Just as Oakland A's manager Billy Beane figured out that on-base percentage is a great indicator of top-flight baseball talent, a solid track record of dividend payment may be one of the best indicators of superior investment opportunities. In fact, Bernstein Global Wealth Management has noted that a dollar invested in stocks between 1926 and 2004 would have turned into nearly $2,300, but without dividends and their compounding magic, the end result shrinks to just $88.

With stock prices still well off their pre-crash peaks, it's possible to find high-quality companies in a variety of industries with dividend yields that put investments like U.S. Treasury bonds to shame.

Source: Yahoo! Finance.

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Fool contributor Matt Koppenheffer owns shares of BP, but does not own shares of any of the other companies mentioned. Google is a Motley Fool Rule Breakers pick. Adobe Systems is a Motley Fool Stock Advisor recommendation. France Telecom and Southern are Motley Fool Income Investor recommendations. Philip Morris International is a Motley Fool Global Gains selection. The Fool's disclosure policy has never once been caught with its pants down. Of course, it doesn't actually wear pants ...