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.

In October, 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, 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, argued in November that "the worst is not behind us." He predicted this recession would last at least 18 to 24 months, with 9% unemployment, stag-deflation, and credit losses approaching $2 trillion.

And, oh yeah, since then we’ve already seen unemployment hit 8.9%, and Roubini’s upped his credit loss estimate from $2 trillion to $3.6 trillion. Yikes!

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 (but after this recent mini-rally), the S&P 500's average P/E (for companies with positive earnings) is still at 15. Wow.

Here's a place to start
Where, then, can we see some of this market cheapness that Buffett is seeing? Not in forward earnings -- Birinyi Associates forecasts the S&P 500's forward P/E ratio at 16.3. Of course, 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 big-time 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 (including some international plays):

Company

P/E Ratio

Johnson & Johnson (NYSE: JNJ  )

11.8

Royal Dutch Shell (NYSE: RDS-A  )

7.2

POSCO (NYSE: PKX  )

7.3

Potash (NYSE: POT  )

9.1

Honeywell (NYSE: HON  )

9.8

Kroger (NYSE: KR  )

11.4

Vimpel Communications (NYSE: VIP  )

6.4

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 retailers today should consider that their earnings just aren't going to be as strong in the next few quarters as they were in the past.

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 what among 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 Motley Fool 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. Just click here. There's no obligation to subscribe.

This article was originally published on Dec. 4, 2008. It has been updated.

Already subscribed to Inside Value? Log in at the top of this page.

Anand Chokkavelu has a P/E ratio of just 2.4 ... the market will wake up one day. He owns stock in Berkshire Hathaway. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation and a Motley Fool Inside Value pick. Johnson & Johnson and Posco are Motley Fool Income Investor recommendations. The Fool owns shares of Berkshire Hathaway and has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (10)

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.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 898428, ~/Articles/ArticleHandler.aspx, 9/20/2014 4:17:39 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement