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. Correct, and correct again.

In October 2008, he wrote an op-ed piece in The New York Times urging investors to start buying stocks. In addition to 2008's Goldman Sachs and General Electric (NYSE: GE  ) preferred-shares-fueled shopping spree on behalf of his company, Berkshire Hathaway (NYSE: BRK-B  ) , he started buying up stocks for his personal account.

The day Buffett penned his Times piece, the S&P 500 closed around 950. A year, a big dip, and a big rally later, we're sitting higher ... but not that much higher (around 18%).

Certainly, we should follow Buffett's lead, right?

Not so fast.

Despite a newly growing GDP, the economic numbers are ugly. Unemployment is at 10%, the next decade's annual deficits are projected to almost double our already $12 trillion-plus national debt, and consumer confidence is still "eh." Yet we've seen the market rise 65% since March. Yikes!

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

Buffett vs. the numbers
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 the numbers 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 the gloomy numbers are right -- if the economy worsens, and the stock market drops again over the next year or two -- we could be looking back three to five years from now, thinking that now 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 all over again. 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 in which it has seen average price-to-earnings ratios of around 8. Even after the free fall we've seen (but after this recent rally), the S&P 500's average P/E (for companies with positive earnings) is 22. Not crazy high, but not crazy cheap either.

Here's a place to start
Where, then, can we see some of this market cheapness that Buffett wrote about? We start to see it in forward earnings -- Birinyi Associates forecasts the S&P 500's forward P/E ratio at 14. That said, I don't trust analysts to begin with, and I certainly don't trust them in the current environment.

No, it's at the individual stock level where I warm up. The pickings are slimmer than a few months ago, when you could get quality companies like Procter & Gamble (NYSE: PG  ) , 3M (NYSE: MMM  ) , and Pfizer (NYSE: PFE  ) for a quarter to half off today's price; still, there are some big-time companies trading at low P/E ratios. When I start seeing P/E ratios in the neighborhood of single digits, I get very interested. Take a look at these companies:

Company

P/E Ratio

Raytheon

11.8

Merck

6.6

Garmin

9.7

Annaly Capital (NYSE: NLY  )

5.2

Petroleo Brasileiro (NYSE: PBR  )

11.5

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 losses in the financial sector. Investors looking at just the trailing earnings a year or two ago would have been tricked into a false bargain.

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 giving us some reasonable prices, 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 recommendation 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.

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

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

Anand Chokkavelu, CFA, has a P/E ratio of just 2.4 ... the market will wake up one day. He owns shares of Berkshire Hathaway and Pfizer. Berkshire Hathaway, 3M, and Pfizer are Motley Fool Inside Value picks. Berkshire Hathaway is a Motley Fool Stock Advisor recommendation. Petroleo Brasileiro and Procter & Gamble are Motley Fool Income Investor recommendations. The Fool owns shares of Berkshire Hathaway and Procter & Gamble and has a disclosure policy.


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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 March 08, 2010, at 11:29 AM, MotleyShark wrote:

    This is why I almost never look at trailing earnings (P/E), except for a reference of where a company <i>has been</i>. Current and future obviously hold a lot more meaning.

  • Report this Comment On March 08, 2010, at 11:33 AM, MotleyShark wrote:

    Which is why I almost never look at trailing earnings, except as a reference of where a stock has _been_. You always want to look at current P/E and/or forward earnings, for obvious reasons. And when those are way undervalued and it's a particularly good company I usually say buy.

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