Your Best Chance to Profit in 2010

If, after 2008, you still expect the stock market to fund your retirement, most people probably consider you a few congressmen short of a bailout. (Zing!) Yes, it was tough being openly optimistic after a year in which every bull became a steer.

But there are a few perks -- like profiting from buying stocks at what could be some of the best prices you'll ever see.

A brief history of 2008
This year was a fantastic demonstration of what happens when, in a highly leveraged world, everyone needs liquidity at the same time.

Anyone who borrowed to buy mortgage-backed securities needed cash as mortgage values plummeted. Investment banks like Bank of America (NYSE: BAC  ) prey Bear Stearns needed cash as the mortgage-backed securities on their books began to fall. Retail banks like Wells Fargo's (NYSE: WFC  ) Wachovia needed cash to maintain their capital ratios as defaults escalated. AIG needed cash to balance its losses in credit default swaps. Hedge funds needed cash to fund redemptions and reduce leverage as assets declined.

The problem is, when everyone needs cash, the only way to get it is to sell off assets. And that's what investors did, dumping almost every asset class with the exception of ultra-safe Treasuries. The stock market took it on the chin.

An overreaction
That's not to say that the market collapsed simply because everyone cashed out. The problems in our economy are real. We've seen huge bankruptcies, the unemployment rate has risen to around 10%, and consumer confidence is low.

But the carnage in the market isn't limited to the shaky companies that are likely to suffer the most. The S&P 500 contains the biggest, most successful, and most stable businesses in America. Yet despite the recent market run-up, more than 74% of the companies in the S&P 500 are down from the start of 2008. Some 10% lost more than half their value!

Certainly, deteriorating business prospects are responsible for some of that drop. But based on valuations, it seems likely that stock investors sold because they had to. Like everyone else, they needed the cash.

And that's a really great thing if you're not one of Wall Street's forced sellers, because it means that despite the broader market run-up in 2009, at least some of those companies remain deeply undervalued -- for now.

The sweet spot
Large-cap value stocks could be the best way to exploit this opportunity. I'm not just talking about slow-growing companies trading at low single-digit earnings multiples, but also compellingly cheap growth stocks.

For instance, these days, the universe of large-cap value stocks includes Apple (Nasdaq: AAPL  ) . Apple has huge barriers to competition, nearly $25 billion of cash on its balance sheet, an innovative culture, and an 18% estimated annual growth rate going forward, and it's trading for about 17 times trailing-12-month free cash flow. At these prices, Apple is a large-cap value stock.

So why are large-cap value stocks a great investment these days? Not because these stocks are certain to outperform the other categories under all circumstances, but because they present the ideal trade-off between risk and reward in these troubling times.

While there's a good chance that the economy will continue showing signs of life this year, there's a possibility that things will get even worse. When you're betting your retirement, you should own businesses that can survive the worst-case scenario.

Low risk, high reward
Generally, large-cap stocks fit that criterion. They have the most stable cash flows, the most well-known brands, the greatest economies of scale, and the best chance of recovering from mistakes.

Would you put your money on PepsiCo (NYSE: PEP  ) to withstand a depression, or Jones Soda (Nasdaq: JSDA  ) ? Would you bet on CVS Caremark (NYSE: CVS  ) , or Rite-Aid (NYSE: RAD  ) ? These two examples may be somewhat hyperbolic, but it's absolutely true that powerhouses like Pepsi and CVS Caremark are far more likely to survive than companies with smaller moats, because they have the financial clout, the economies of scale, and the proven, winning business models.

In normal times, you'd really have to pay up for these sorts of dominant companies. But thanks to forced selling from investors struggling to raise cash, right now you can still find some excellent businesses extremely cheap.

What's more, thanks to the poor economy, the earnings of these powerhouse companies have been depressed this year, which means that their normalized earnings multiple is even more compelling. Large-cap stocks are still cheap, and I believe they will offer superior returns over the next few years.

The Foolish bottom line
Of course, you still have to be careful -- as 2008 has shown us, you can't just throw a dart at the S&P 500 and expect to strike it rich. You still need to pay attention to balance sheets, and monitor how much cash companies are bringing in during these troubling times.

But if you're alert, you can find the stocks right now that will pay for your retirement. So now is a good time to start buying large-cap value stocks. If you're interested in ideas, our Motley Fool Inside Value team has identified the dirt cheap stocks that we think offer the most enticing combination of safety and upside potential. You can read our complete analysis with a 30-day free trial.

Already a member of Inside Value? Log in at the top of this page.

This article was originally published Jan. 8, 2009. It has been updated.

Fool contributor Richard Gibbons knows all too well the pain of becoming a steer. He doesn't own shares of any company mentioned. Apple is a Stock Advisor selection. Motley Fool Options recommended a diagonal call position on PepsiCo, an Income Investor pick. The Fool's disclosure policy wears a large cap to avoid sunburn.


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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 March 02, 2010, at 2:47 PM, EighthrillSeeker wrote:

    Bank of America and Merrill Lynch's recently reported numbers indicates that approximately $1 trillion in assets has been cleared from their wealth management division since their merger in September 2008. Bank of America reported approximately $700 billion in their wealth management division, however this included Merrill Lynch's wealth management division as well. In September 2008, Merrill Lynch had reported an estimated $1.5 trillion in assets under management. 2008 Q3 figures detail that Bank of America had approximately $550 billion in assets under management, leading to over $1 trillion now off their books since Merrill Lynch and Bank of America merged.

    However, Bank of America Merrill Lynch's global wealth management division reported a rise in net income despite outflows of assets under management reported by the global wealth management division.

    The outflows of cash displayed by Bank of America reveal an opportunity for high net worth wealth managers, financial advisers, and wealth strategists. As clients withdrawal their assets from larger financial institutions, those wealth managers and financial advisers who recognize their movements can create opportunity for themselves and their firms.

    Although the "chaos" and "instability" of the current market has undoubtedly affected all financial sectors, the current time is opportune for those advisers and wealth managers to increase their practices and new business production.

    ---------------------------

    www.intelligentinvestingtips.com

  • Report this Comment On March 02, 2010, at 2:48 PM, EighthrillSeeker wrote:

    Bank of America and Merrill Lynch's recently reported numbers indicates that approximately $1 trillion in assets has been cleared from their wealth management division since their merger in September 2008. Bank of America reported approximately $700 billion in their wealth management division, however this included Merrill Lynch's wealth management division as well. In September 2008, Merrill Lynch had reported an estimated $1.5 trillion in assets under management. 2008 Q3 figures detail that Bank of America had approximately $550 billion in assets under management, leading to over $1 trillion now off their books since Merrill Lynch and Bank of America merged.

    However, Bank of America Merrill Lynch's global wealth management division reported a rise in net income despite outflows of assets under management reported by the global wealth management division.

    The outflows of cash displayed by Bank of America reveal an opportunity for high net worth wealth managers, financial advisors, and wealth strategists. As clients withdrawal their assets from larger financial institutions, those wealth managers and financial advisors who recognize their movements can create opportunity for themselves and their firms.

    Although the "chaos" and "instability" of the current market has undoubtedly affected all financial sectors, the current time is opportune for those advisors and wealth managers to increase their practices and new business production.

    -------------------------

    www.topinvestingtips.com

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