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If you're nervous about the stock market, you're not alone. But even amid all the uncertainty surrounding the economy right now, you can pick up some good values on attractive, high-quality stocks if you think something other than the worst-case scenario will end up happening.
A depressed market
You'll always find permabears who believe that the sky is falling. However, today's pessimism isn't confined just to the usual Chicken Littles. Even well-respected market experts like Peter Schiff believe we're in the early stages of a depression that could send commodities prices soaring, while leaving many investors in U.S. stocks and bonds suffering huge losses.
Because of those fears, many stocks are priced at extremely attractive valuations right now. With short-term interest rates near zero, price-to-earnings ratios of 10-12 imply a risk premium for stocks of 8% to 10%. You can find relatively cheap stocks across the economy, from traditionally defensive sectors to cyclical and even growth stocks. Let's look at some of these bargains, the short-term reasons why they're trading cheap, and why they might make good investments going forward.
When I talk about "defensive stocks," I'm referring to companies that traditionally hold up fairly well, even during periods of slow economic growth. After all, no matter how bad things get, there are certain things that people need to buy; the companies that provide those goods aren't completely immune from recessions, but they often see less dramatic downturns in their financials than producers of goods that people can live without.
Johnson & Johnson (NYSE: JNJ ) makes everything from Band-Aids to prescription drugs, but it's faced several headwinds lately. A stronger dollar, health-care reform, and a host of product recalls have all conspired to force the company to lower its earnings guidance. But with a P/E ratio of 12 and a 3.7% dividend yield, you don't need much growth to make this stock a good value.
Other stalwarts are facing similar short-term problems. Wal-Mart (NYSE: WMT ) , which weathered the 2008 bear market quite well, has seen recent earnings fall short of hopes, as investors question whether hurting consumers will stick with the discount retailer for the long term. ExxonMobil (NYSE: XOM ) has faced the double-whammy of the Gulf oil spill and low natural gas prices that have called into question its acquistion strategy. But both companies trade at earnings multiples of around 12 to 13, and both pay handsome dividends. More importantly, few investors foresee long-term troubles for either company.
Playing the cycle
You might expect defensive stocks to underperform at the end of an economic downturn. But cyclical stocks are also struggling. Freeport-McMoRan Copper & Gold (NYSE: FCX ) trades at a P/E of just 9, even though analysts expect double-digit earnings growth both in 2011 and in the coming five years.
For European steel giant ArcelorMittal (NYSE: MT ) , the gains could be even larger. An expected 50% jump in 2011 earnings could bring multiples down from 11 to below 9. Yet even if that growth doesn't pan out, it's hard to argue that these cyclical stocks are overvalued.
The technology industry is known for ridiculously overpriced stocks that stay overpriced all through their lengthy growth periods. Right now, though, even tech is cheap.
No one can say that Microsoft (Nasdaq: MSFT ) doesn't have its challenges, from defending its strong position in the web-browser and office-software markets to trying to compete in online search, smartphone, and tablet niches. But even if Microsoft stays clueless, its current earnings support both a 2% dividend and huge share repurchases that return capital to investors.
Even among faster-growing stocks, valuations have become reasonable. Even after tripling in price in a year and a half, Apple (Nasdaq: AAPL ) still trades with a trailing P/E below 20. An estimated growth rate around 20% doesn't seem completely unrealistic for Apple, given the speed with which its new products have come to dominate their markets.
Many investors are ignoring this opportunity, piling instead into Treasury bonds that pay 2% to 3% or less. Don't make that mistake. Given how rare it is to have opportunities to buy stocks like these at bargain prices, you won't want to count on these deals lasting forever.
Do you think I'm crazy to like stocks? Let me have it in the comments section below.
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