Our so-called junk rally has been unusually kind to financial fare, with the likes of Goldman Sachs, XL Capital (NYSE: XL), and Ameriprise Financial (NYSE: AMP), for example, sporting huge returns year to date.
Never mind the still-fragile state of the economy, not to mention those toxic assets we used to hear so much about: They remain toxic. Nonetheless, a deeply bought-into belief that happy days are here again has led to yet another spiked punch bowl -- and with the lampshade only recently fastened back on the lamp and the glass cleaner barely dry on the copy machine, too.
Indeed, thus far in 2009, the Financial SPDR (XLF) -- an exchange-traded fund whose top holdings include big boys Wells Fargo (NYSE: WFC), American Express (NYSE: AXP) and JPMorgan Chase (NYSE: JPM) -- has risen by more than 20% despite the near-meltdown of the financial system as we know and loathe it.
Party on, Wayne
Yes indeed: The market is drunk yet again, and it's not just financials that are partying hard.
Sirius XM Radio is another triple-digit gainer on the year, despite its 0-for-10 free cash flow record every fiscal year over the past decade. And while Freeport-McMoRan Copper & Gold is, admittedly, a sturdy operator, its fortunes (or misfortunes, as the case may be) are tethered to the mercurial demand for commodities. When the current gold fever breaks, a stock price that has increased by nearly 250% this year is going to strike some folks as fool's gold.
What goes up ...
Parties are fun while they last, but no Fool should be the last to leave. Investing ain't Sunday school, it's true, but fundamentals (and, um, fundamentalist investors) will eventually trump a "technical" rally, a rise powered in large measure by the fact that money has begun flowing back into equity mutual funds, and money managers don't get paid to sit on cash.
To snip the title from a favorite Fool commentary, the bottom line is this: Danger, horror, get out! Unlike that must-read write-up, though, no irony is required here. Now really is a great time to cash out of clunkers and trade up to tougher stuff -- vehicles poised to provide greater mileage over the long haul.
Two for the road
IBM (NYSE: IBM), for example, is trading with a below-market P/E despite rock-solid profitability and deep-pocketed financial health.
Meanwhile, health-care sector dweller Merck (NYSE: MRK) looks intriguing, too, with concerns about coming (eventually!) health-care cost controls more than priced in. In the near- to mid-term, those controls don't appear likely to have much bite. And the emerging reform legislation seems poised to dramatically increase what is, in the broadest sense, Merck's customer base: the insured.
Art and science
No matter what data swirls around it, though, free cash flow (FCF) is my mainstay metric. Add up the cash a company has taken in from operations, subtract its capital spending, and voila: FCF, the lifeblood of any going concern that aims to remain a going concern.
The science of analyzing FCF involves assessing the present value of a company's future cash flows. And then the art kicks in -- determining whether a stock's current price is right in light of the return you require, given its risk and how wide your margin of safety must be.
That latter phrase refers to the gap between a company's stock price and your estimate of its intrinsic value. And that's where I'm currently stuck with both IBM and Merck. Attractive in fundamental terms though they are, both currently trade above my buy-below price -- and therefore outside my margin of safety.
Bargains galore!
I'm a patient Fool, though, particularly when bargains abound elsewhere and are being conveniently served up on a silver platter. To wit: Even after the market's fast and furious run-up, the list of recommendations at Motley Fool Inside Value -- a service for dyed-in-the-wool cheapskates like moi -- includes more than a dozen companies trading at huge discounts to their intrinsic value.
If you're looking to winnow your watch list down to just those stocks you might actually buy, you can check out Inside Value's complete list of recommendations for the low, low price of ... free. No investment is risk-free, of course, but there's a margin of safety in Inside Value's numbers. Click here to take the service for a 30-day, no-cost spin.
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This article was originally published on Sept. 8, 2009. It has been updated.
Shannon Zimmerman
runs point on the Fool's Duke Street and Ready Made Millionaire services, and he runs off at the mouth each week on Motley Fool Money, the Fool's fast 'n' furious podcast. Shannon doesn't own any of the stocks mentioned. American Express is an Inside Value pick. You can check out the Fool's strict disclosure policy right here.
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