Now Is the Time to Invest and Get Rich

Not my words. Those were Warren Buffett's. Back in 1974. He turned out to be right.

Earlier this decade, he warned about the insane valuations during the Internet bubble and the dangers of derivatives. Right and right.

A month ago, he wrote an op-ed piece in The New York Times urging investors to start buying stocks, specifically American stocks. Aside from his recent shopping spree on behalf of his company, Berkshire Hathaway (NYSE: BRK-A  ) , he has started buying up American stocks for his personal account.  

Certainly, we should follow his lead, right?

Not so fast.

One dissenter stands out. Nouriel Roubini, the NYU economics professor famous for predicting our economy's current problems back in 2006, recently argued that "the worst is not behind us." He predicts this recession to last at least 18 to 24 months, with 9% unemployment, stag-deflation, and credit losses approaching $2 trillion.

According to his calculations, we could easily see the S&P 500 drop to 600, about 30% below where it trades today.

Who's right? Is now another time to invest and get rich? Or is the market a sucker's bet?

Buffett vs. Roubini
Before I answer those questions, let's be clear. This isn't a market-timing discussion. We Fools believe there's no proven way to consistently time the market. Even Buffett admits that he can't predict the short-term movements of the market. He thinks in years and decades, not days and months. After all, he's the guy whose favorite holding period is forever.

Back to the question at hand. Don't be surprised if both Roubini and Buffett are right. The economy and the stock market could get worse from here, but it could still be a great time to invest and get rich.

Huh?

Remember, since we can't time the market, we're talking only about money you can keep in the market for the long term. Unlike Jim Cramer, we Fools have always said that money you need in the next three to five years should never be in the stock market. As the last year has shown, it's just too darn volatile for money you need in the short term. 

So even if Roubini is right -- the economy worsens and the stock market drops even more over the next year or two -- we could be looking back three to five years from now thinking that 2009 was a great time to invest and get rich.

OK, but how bad could it get?
Before you start putting some of your idle cash into stocks, know that it could get a whole lot worse. Fellow Fool Morgan Housel showed just how much worse in "How Low Can Stocks Go?"

Long story short, the S&P 500 has had long stretches where it has seen average price-to-earnings ratios of around 8. Even after the freefall we've seen, the S&P 500's average P/E is still at 19. Yikes! 

Of course, the trailing P/E ratio is an imperfect measure of cheapness. For example, consider that the massive negative earnings rampant in the financial sector are lowering the denominator, thus inflating that 19 figure.

Here's a place to start
Where, then, can we see some of this market cheapness Buffett is seeing? Well, Birinyi Associates forecasts the S&P 500's forward P/E ratio at just below 12, but I don't trust analyst earnings estimates to begin with, and I certainly don't trust them in the current environment. (Roubini calls 2009 consensus estimates "delusional.")

No, it's at the individual stock level where my eyes pop. We have blue-chip companies trading at minuscule P/E ratios. When I start seeing P/E ratios in the neighborhood of 10 and below, I get very interested. Take a look at these companies:

Company

P/E Ratio

Accenture (NYSE: ACN  )

11.2

General Dynamics (NYSE: GD  )

8.5

GE (NYSE: GE  )

8.6

Aetna (NYSE: AET  )

6.2

Best Buy (NYSE: BBY  )

7.3

Rio Tinto

2.5

Valero (NYSE: VLO  )

3.4

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

Ah, but remember my warning earlier. P/E ratios are an imperfect measure of cheapness.  They're just a place to start, because a company's future earnings can be very different from its trailing earnings. See the aforementioned losses in the financial sector. Investors looking at just the trailing earnings a year ago would have been tricked into a false bargain. Similarly, investors looking at Best Buy today should consider that its earnings this holiday quarter aren't going to be as strong as they were for last year's.

Should you buy?
Investors are clearly fearful of the future earnings of the stocks in the table above. That's why they're trading at such low P/Es. The market is throwing a sale, but it's up to you to determine which of its merchandise is worth buying.

A simple metric isn't going to cut it. That's a great place to start, but you have to do your research and determine what you believe a company's future earnings power will be. Only then can you judge whether a company is a value or a value trap.

Our Inside Value team spends its days (and sometimes nights) doing just such analysis. They break each potential stock pick down, determine its earnings power, and then figure out whether it's a good value. If you'd like to see the companies that have made their buy list, a 30-day trial is free. There's no obligation to subscribe.

Anand Chokkavelu has a P/E ratio of just 2.4 … the market will wake up one day. He owns shares in Best Buy and Accenture. Berkshire Hathaway, Best Buy, and Accenture are Motley Fool Inside Value selections. Berkshire Hathaway and Best Buy are also Stock Advisor recommendations and Motley Fool holdings. The Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (82)

Comments from our Foolish Readers

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 04, 2008, at 7:35 PM, 181736065 wrote:

    "We have blue-chip companies trading at minuscule P/E ratios. When I start seeing P/E ratios in the neighborhood of 10 and below, I get very interested."

    Yep. Like you also say, the key is making sure that these earnings won't be compressed as the economy takes its toll and (I'll respectfully add) that the capital structure of these companies is sound, market opportunities will continue to exist and hopefully expand, and that the management is talented.

    Agreed, otherwise. These levels are good buying opportunities for those with long-term horizons.

  • Report this Comment On December 04, 2008, at 9:28 PM, FinancialFellow wrote:

    Another article that talks about specific stocks and doesn't talk about just buying and index fund and sitting on it for several years. Alas...I suppose index funds are rather boring.

    The author brings up a good point on both Roubini and Buffet being correct. I suspect they both will be right. (Although I'm going to guess that the market won't fall quite as far as Roubini suspects it could). With all the great buying opportunity it raises a good question: Should you borrow money to invest in the market? Here's a good related article: http://financialfellow.com/2008/12/01/reader-email-question-...

  • Report this Comment On December 04, 2008, at 10:01 PM, TMFBomb wrote:

    Agreeing with your points, fe3lixallen...all of those factors go into figuring out future earnings. For example, if a company goes bankrupt due to a poor capital structure, future earnings will be snuffed out.

    FinancialFellow, regular purchasing of index funds is a great option. Picking individual securities is only for those who have the time, inclination, risk tolerance, and patience to do so.

  • Report this Comment On December 05, 2008, at 10:08 AM, toraab wrote:

    Hi

    Nobody knows what will the future bring and neither do Warren Buffet.

    It's hard to invest in something and see all your money going away.

    I think That you do need to have some start/end strategies for your restful mind.

    I played a bit with www.histocky.com and tried to see how I'm handling a loss and profit, when I get my money out and when I get some more money into action.

    Nobody tells how to invest exactly...

    I don't want to lose money on my errors, I preffer them to be free of charge and learn from the past movement of the stocks.I'm glad I found histocky.com

  • Report this Comment On December 05, 2008, at 10:17 PM, TimothyVR wrote:

    I'm still new enough to all of this to be completely confused by the various P/E ratio comments. An S&P P/E of 19? That's by far the highest I have seen anywhere.

  • Report this Comment On December 12, 2008, at 1:20 PM, yonko3 wrote:

    You mentioned that "unlike Jim Cramer" who recommends that investors stay in the market rather than gathering cash.

    That is wrong! I'm not a super fan of Cramer but I do remember his stating early on months ago that investors should take the money out of the market that will carry them through a multi year down turn.

    This included college money.

    I can remember this vividly because it was contrary to the usual Cramer market investment discipline.

    J. Miller

    Dover, Ohio

  • Report this Comment On December 12, 2008, at 7:03 PM, techquotes wrote:

    I will second that.

    Anand - You are MISLEADING that Cramer tells investors to continue even if they need money in next few years. He has repeatedly said that if you need money in next 5 years, don't put it in the stock market and he has suggested safer bonds.

    This article is incomplete w/o talking about the PEG ratio, which is a good barometer of the stocks performance and comparison.

  • Report this Comment On December 12, 2008, at 7:31 PM, dfmatson wrote:

    Who has the higher net worth, Roubini or Buffett?

  • Report this Comment On December 15, 2008, at 9:19 AM, fibreoptik wrote:

    @ $27 I will not be buying BestBuy right now... wait until the dismal Christmas sales figures are released in the New Year, the whole retail industry is gonna tank in a big way. The blood in the streets will be knee-deep and I will be waiting with cash in hand (hopefully).

  • Report this Comment On December 17, 2008, at 11:07 AM, jfenlon wrote:

    I majored in Bus. Admin. and Finance 50 years ago because I was too intellectually deficient to become a biologist, chemist, doctor, or engineer. Was a callow youth who learned lttle and forgot that.Still working and will be for two more years. So what I'm about to say may not be worth much. But - All this talk about a company's current financial postue with various formulas to determine its health remind me of what a CPA told me years ago: "Remember, balance sheets and other financial documents tell you where you've been, not where you're going". May I suggest to the less technically proficient the following: in evaluating a company try to determine three things:

    Does it make something people need or something they want? (3M, Kraft)

    What is their market share? (McDonalds, Wal-Mart, MicroSoft)

    Who are their competitors? Are they gaining?

    If you can answer these questions you may be able to determine where a company will be, and you can get the answers by reading the WSJ and the Economist and just keeping your eyes open as you drive around. I realize this is conservative, but it avoids things like derivatives, which, until this latest bomb, I thought was a calculus function.

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