I said my piece last week about the market's recent bender, dubbing it "ridiculous" and inspiring a legion of readers to heap on potshots (comes with the territory) and praise (thanks, Dad!).
One comment in particular resonated with me:
Are investors are losing their minds? Back when the Dow was 14,000 who would have thought that at Dow 8,400 people would be complaining about irrational exuberance because the market was too high? This really is laughable. Buffett liked stocks when the market fell to 10,000 and I have to think fair value for the market is still above 8,400. Dow 6,600 was a fiercely manic over correction and I wouldn't bet on getting back to it.
Fair point -- up to a point
The phrase "fair value" caught my attention. In my opinion, a market that's fallen more than 50% from its peak may or may not be fairly valued. After all, aggregate valuation -- which indices provide -- takes the good, the bad, and the ugly, and rolls 'em up into one easy-to-grok number.
Properly dissected, that number can be useful for identifying broad areas of fish-in-a-barrel opportunity. Reeling in keepers, though, requires fair value work on individual names. Indeed, the market's recently rising tide has lifted even the leakiest of boats, with the likes of Bank of America (NYSE: BAC ) , Citigroup (NYSE: C ) , and Wells Fargo (NYSE: WFC ) all sprinting to gains of more than 50% over the past month.
That makes no sense. After all, each of the above companies apparently requires even more cash. Not coincidentally, they also sport balances sheets riddled with more mysteries than Clue.
Colonel Mustard, meet thy candlestick
If Wall Street really does hate mystery, color me mystified by its reaction to the market's current page-turner.
Whichever way market winds blow, though, opportunities abound among companies that lend themselves to, you know, actual analysis instead of Agatha Christie-style intrigue.
In terms of whittling down a massive stock-shopping wish list, I recommend focusing at first on two key metrics: free cash flow (FCF), the lifeblood of any company that wants to remain a going concern, and managerial acumen, as gauged by return on equity (ROE).
Metric(s) system
A pair of aces quickly make that cut: IBM (NYSE: IBM ) and Gilead Sciences (Nasdaq: GILD ) , each of which has generates loads of FCF. The honchos in charge have been highly effective stewards as well, wringing out double-digit profitability as measured by ROE. 10% or higher is a good absolute hurdle for that metric, one these companies have consistently cleared.
More critical, though, is how a firm has fared relative to likeminded rivals. The tech sector's profitability profiles vary widely from, say, those of health-care concerns. The good news is that both these companies look great in apples-to-apples terms, too.
The not-so-good news
Alas, the investment case for both looks less clear when we turn from the fundamental side of the equation to valuation spadework. Even great companies can prove lousy investments if the stock price isn't right. Both trade below my estimate of fair value, but not far enough below to cause my inner value hound to start howling for a buy order.
Though the recent broad-market rally strikes me as ridiculous, there are some strong, undervalued names whose rallies are righteous. Two such companies -- eBay (Nasdaq: EBAY ) and Flowserve (NYSE: FLS ) -- look intriguing, with strong fundamentals matched by stock prices that remain bargains even their run-ups. Both currently trade with below-market P/Es, in fact, despite solid track records of revenue growth, FCF generation, and profitability.
Trifecta?
eBay appears on the real-time scorecard of our Inside Value service, where members have enjoyed fat and happy double-digit gains since it was recommended. While the stock trades at a discount to the team's estimated intrinsic value, it's moved above their recommended buy-below price.
The good news is that Inside Value is chock-full of other top-notch, dirt cheap recommendations. If you're looking for more stock ideas, you can click here to see all of their favorite stocks, free for the next 30 days. There no obligation to subscribe.
Shannon Zimmerman runs point on the Fool's Duke Street and Ready Made Millionaire services. eBay is both a Stock Advisor and Inside Value selection. The Fool owns shares of Flowserve. Shannon doesn't own any of the stocks mentioned in this article. You can check out the Fool's strict disclosure policy right here.
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