What to Buy When Nothing's Cheap

Smart investors look for great values among investments. But when the prices of everything seem to be going straight up, what's a good value investor supposed to do?

What the rally did
After a big run-up like we've seen over the past year, it's no big surprise that the pickings for value seekers have started to get a little thin. But I didn't realize just how thin until I took a look at the new 52-week lows list.

Typically, checking out which stocks are hitting new lows for the year can uncover a treasure chest for value hunters. Seeing what investors have beaten down and left for dead last year, for instance, would have given you so many strong ideas that you would've had trouble looking into them all.

Yesterday, though, I found only a single regular stock on the NYSE list: TerraNitrogen. The Nasdaq list was no better: I didn't find a single stock with a market cap over $100 million on it. So much for easy pickings!

What got left behind
Unfortunately, when the stock market goes up 60% in a year, it's going to carry a lot of stocks along with it. You're not going to see very many stocks lose money during such a powerful rally, especially if you tend to focus on large-cap stocks.

What you will see, though, are stocks that don't go up as much as the overall market. Look at stocks like Qualcomm (Nasdaq: QCOM  ) and Activision Blizzard (Nasdaq: ATVI  ) , for instance, and you'll see that they're up only 15% and 11%, respectively, since this time last year. Yet not all such stocks look like huge bargains; both of those stocks have trailing price-to-earnings ratios above 30, yet analysts don't see a huge amount of earnings growth in the near future.

To find the best values available at today's prices, you'd ideally like to see all three of these attributes:

  • Modest share price growth over the past year.
  • Reasonable valuations.
  • Prospects for future growth that are in line with current valuation.

It's always tough to find the perfect mix of those characteristics. But here are some stocks that do a reasonable job at that balancing act:

Stock

1-Year Return

Current P/E

EPS Growth Estimate for Next Year

ExxonMobil (NYSE: XOM  )

2.1%

16.4

27.0%

Wal-Mart (NYSE: WMT  )

13.1%

14.6

9.5%

McDonald's (NYSE: MCD  )

23.9%

15.4

8.8%

Abbott Labs (NYSE: ABT  )

18.5%

14.6

12.5%

FirstEnergy (NYSE: FE  )

2.9%

11.8

13.3%

Source: Yahoo! Finance.

None of these stocks has done all that well during the rally. Yet they're all slated to see some decent earnings growth in the next year as the recovery takes hold -- without the high valuations that would keep those stocks from being worth your while.

Grab the bonus
Curiously, all five of the stocks in the table above share another trait you may not have expected: Each of them pays a good-sized dividend of 2% or more. That's especially valuable if you're looking to draw some immediate income from your stock portfolio.

But even if you're still firmly in the wealth-accumulation phase of your life, those dividend payments also give you a sign of confidence that the company has generated the cash flow necessary to finance their payouts -- and that it expects to continue to be able to do so in the future. Given just how disruptive the market meltdown and the breakdown in the credit markets were to less financially secure companies, you shouldn't discount the peace of mind that dividend stocks provide by exercising the fiscal responsibility necessary to raise enough cash to pay their dividends year in and year out.

There's always value
Value investors are among that rare crowd that gets disappointed when share prices go up, as it means that the best opportunities to invest become a bit less attractive. But even as the stock market has risen, good value stocks haven't disappeared entirely. You just have to know where to look and be willing to pay something more than the rock-bottom prices that prevailed last year. Over the long haul, though, the investments you make today may well be just as profitable as any other one you make.

Want cheap stocks? Tim Hanson can show you some good ones that cost less than a sandwich.

Fool contributor Dan Caplinger often buys nothing when nothing's cheap. He doesn't own shares of the companies mentioned in this article. Wal-Mart is a Motley Fool Inside Value recommendation. Motley Fool Options has recommended a synthetic long position on Activision Blizzard, which the Fool owns shares of and which is a Motley Fool Stock Advisor selection. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy is worth its weight in gold.


Read/Post Comments (5) | Recommend This Article (18)

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 05, 2010, at 1:44 PM, goalie37 wrote:

    There are some great companies in that list. Also take a look at General Dynamics. Very cheap according to several metrics and just raised their dividend yesterday.

  • Report this Comment On March 05, 2010, at 4:16 PM, gambatteimasu wrote:

    Dan, why no mention of Interdigital (IDCC)? Seems perfect for the theme of your article.

    Plus, back out the huge (and growing) pile of cash, and the valuation appears laughably cheap -- especially in this market environment.

    Thoughts/opinions?

    gambatte imasu

    long IDCC

  • Report this Comment On March 06, 2010, at 4:24 AM, daveandrae wrote:

    I have been holding McDonald's since 2003. Great stock. Would I add to my position at these price levels? No. With that said, I have no intention of selling a single share, either.

    Right now, I think Pfizer is cheap. Average earnings over the last three years were 1.25. Average earnings over the last five years come in at 1.50. And average earnings over the last ten years come in at 1.28, at an annualized growth rate of 7%. Book value as of 12/31/09 stood at 11.11 per share. Right now, you're getting 63 cents of assets, for every dollar you invest in the business.

    Ironically, this is the same valuation McDonald's was selling for back in 2003, when I began buying that stock at 13.60.

    Will Pfizer make the same kind of run over the next seven years? Who knows, really. But when a stock is yielding 4% in cash, and trading at less than 14 times the ten year average in earnings, against a 7% growth rate, there seems to be little, if any downside, in my opinion. The PEG ratio is obviously well under one, and the company is buying back its own stock. Pfizer is certainly a hell of lot cheaper than ANY of the major indices.

    It does not take a rocket scientist to realize that this particular business is both unpopular and large. Which makes it a classic case study for a Ben Graham type of investor.

    Thomas Edmonds

  • Report this Comment On March 07, 2010, at 8:42 PM, starbucks4ever wrote:

    They haven't risen as much as the market because they never fell as much. They are not necessarily very cheap now.

  • Report this Comment On March 11, 2010, at 11:06 PM, bigkansasfool wrote:

    This article isn't directed to value investors at all. Ask Buffett. True value investors aren't putting money into the market just to have it in the market. They're sitting on the cash waiting to put it to work in an actually value stock. Also the premise that because a stock didn't rise with the rest means it is undervalued is utter hogwash.

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