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.

Company

Forward P/E

Forward Earnings Yield

CME Group (NYSE: CME  )

21.8

4.6%

Adobe Systems

22.1

4.5%

Celgene (Nasdaq: CELG  )

21.2

4.7%

Google (Nasdaq: GOOG  )

23.0

4.3%

PotashCorp (NYSE: POT  )

23.6

4.2%

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.

Company

Industry

Dividend Yield

BP (NYSE: BP  )

Energy

5.9%

Merck (NYSE: MRK  )

Pharmaceuticals

4.2%

Philip Morris International (NYSE: PM  )

Consumer Staples

4.7%

France Telecom

Telecom

6.6%

Southern Co.

Utilities

5.3%

Source: Yahoo! Finance.

The trick, of course, is to find the best companies with solid dividends and room to grow their payout. That is exactly what the investment team at the Motley Fool Income Investor newsletter focuses on each and every day. This group of yield-hungry investors has put together a portfolio of high-quality dividend-paying stocks that has handily bested the S&P 500's return since the newsletter's 2003 inception.

And the best part? You can take a free 30-day trial of Income Investor to check out exactly which stocks the team thinks are your best bets today. 

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 ...


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 11, 2009, at 10:24 AM, paducah5102 wrote:

    Most of you folk can't seem to be bothered to be consistent and include the letters that refer to the stock that one might like to buy. It just looks like laziness and indifference. Include the ticker on EVERY stock that you mention

  • Report this Comment On December 21, 2009, at 4:26 PM, MaxPower13 wrote:

    YEAH, WHAT HE SAID!! And if one of y'all could stir my coffee for me every day, that'd be great. If not, YOU'RE JUST LAZY AND INDIFFERENT!!

    In all seriousness, not that anybody is paying attention to this 10-day old article, but Billy Beane is Oakland's GM, not their manager.

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