This Quality Stock Is Trading Dirt Cheap

A good friend of mine recently told me that his financial advisor was ready to start buying stocks because he was finally convinced we're "in a bull market."

After waiting for nearly eight months to get in the game, now he's ready to buy.

My response: "Fire your financial advisor."

What?
First, let me explain myself.

I'm not here to sell you on a doomed market, but I would like to illustrate that it's no longer a buyer's market. This is, believe it or not, a bull market. Let me give you three good reasons I think so:

  1. Investor confidence, a key factor in determining the upward trend that marks a bull market, has been on the rise. In fact, since its 2008 lows, the index has risen by 32% and now rests at a healthy 108.
  2. The American consumer is back. Retail sales ticked upward in February. Not only have quarterly sales increased, but year-over-year, they've also increased by 3.9%. This means that people have more money in their pockets, and they're not just buying suits and iPhones -- they're buying stocks by the handful.
  3. The S&P 500 has seen gains of 42% in the last year and recently hit a 17-month high.

"So what?" you're probably thinking.

Well, bull markets are great -- after all, a rising tide lifts all boats. It's just that there aren't as many bargains out there anymore.

Sure, at first, it was just turnaround stocks such as Sirius XM Radio and Las Vegas Sands that were seeing stellar gains. But now it's blue chips as well. Companies such as General Electric (NYSE: GE  ) and Caterpillar (NYSE: CAT  ) have risen in the last year by 67% and 107%, respectively. In fact, look at what five of the largest stocks of the S&P have done in the past year:

Company

1-Year Percentage Return

Microsoft (Nasdaq: MSFT  )

57%

Procter & Gamble (NYSE: PG  )

28%

Bank of America

104%

Wells Fargo

71%

Apple

109%

GE is trading at about 19 times earnings, which is pretty much in line with its P/E over the past five years. Yet as recently as December, you could have grabbed this monster conglomerate for about 3.7 times earnings. The same can be said for Caterpillar -- this star machinery master has sold for about 14 times earnings over the past five years. Now it's trading well above 38 times earnings!

I can't say that all the stocks listed above are overpriced -- Microsoft sports a P/E of 17, and P&G is trading for 15 times earnings. Both are pretty reasonable when considering their historical data.

But the bottom line is that while my friend's advisor was waiting for confirmation of a surging market, well, the market surged ahead! And now, stocks just aren't flying on the cheap anymore.

So what's a value investor to do?
John Neff, star investor and manager of the Vanguard Windsor Fund for more than 30 years, once said that "as bull markets progress, prevailing wisdom becomes a drumbeat that drowns out the argument for a low P/E strategy."

Well, I'm here to argue for that low P/E strategy.

You have to remember that half the battle of investing may be finding the right stock, but the other half is making sure you find it at the right price.

So in this type of market, you need to search high and low for value stocks -- companies that, for no good reason, are trading well below their true worth. Buying cheap means you don't have to time the market (like my friend's financial advisor) -- your only worry is making sure you purchased a great company at a reasonable price.

One angle you can use is to identify a company with a low P/E and then make sure to compare it with historical P/Es. Because maybe you found a stock trading for a multiple of 15, but if that's close to its historical norm, and the company's growth prospects haven't changed, then you haven't found much of a bargain. Target (NYSE: TGT  ) is an example; its 17 P/E is close to its eight-year average of 18.8.

Once you've found a stock that's trading below its historical P/E, then just make sure it has the other fundamentals -- sound management, a good balance sheet, room to run, and preferably, a solid yield. eBay (Nasdaq: EBAY  ) doesn't pay a dividend, but it otherwise fits the bill. Its current P/E of 15 is well below its historical average.

And that's what our analysts do at Inside Value -- they're constantly scouring the market for companies that have competitive advantages, that can provide long-term value, and, most importantly, that are trading at dirt-cheap prices.

If you like buying stocks at outrageous prices and high multiples, then please, by all means, start gobbling up stocks like it's nobody's business.

But if you're like me, and you appreciate a good sale and like buying stocks for less than they're worth, then Inside Value is probably the place for you.

This baby is dirt cheap
The folks on our team consistently find companies that fit this bill -- in fact, they recently recommended a company that's trading well below its worth -- Exelon (NYSE: EXC  ) .

This company owns two utility companies in the Northeast, but its real bread and butter is power generation from its 17 nuclear reactors, which together account for 20% of U.S. nuclear capacity. It produces gobs of free cash flow and has a pretty wide moat, considering no company has started to build a nuclear plant since the 1970s. The best part is that it has all the classic characteristics of a value champion. It's trading at 11 times earnings, well below its five-year average of 31 times earnings. It has a reasonable debt/capital ratio, and because of all its free cash flow, it's able to fork out a solid 4.7% dividend yield.

Last but not least, because it's selling for such a reasonable price, our analysts see it trading for about 37% below its true value. And that's one of the many reasons it's one of our team's Best Buys Now recommendations.

Of course, you shouldn't just take my word for it and throw all your money into Exelon. That's why, to help you in your quest, I'd like to offer you a free 30-day, all-access pass to our Inside Value service. That way, you can get in-depth research on Exelon, plus full coverage of all our past and present recommendations, in addition to the seven stocks you need to "buy now." To learn more, simply click here.

Fool contributor Jordan DiPietro owns shares of General Electric and Exelon, which he also just publicly called to outperform the market in Motley Fool CAPS. Microsoft and Exelon are Motley Fool Inside Value recommendations. eBay and Apple are a Motley Fool Stock Advisor picks. Procter & Gamble is a Motley Fool Income Investor selection. Motley Fool Options has recommended a bull call spread position on eBay and a diagonal call position on Microsoft. The Fool owns shares of Procter & Gamble and has a disclosure policy.


Read/Post Comments (13) | Recommend This Article (109)

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 April 17, 2010, at 6:16 PM, Patricia013 wrote:

    "Once you've found a stock that's trading below its historical P/E, then just make sure it has the other fundamentals -- sound management, a good balance sheet, room to run, and preferably, a solid yield. eBay (Nasdaq: EBAY) doesn't pay a dividend, but it otherwise fits the bill."

    Are you serious???? "sound management" from a CEO and team who have just had their compensation packages slashed - Donahoe slashed a mere 55 percent!!!! Outside of paypal (which will have competition soon enough) Ebay is failing! You do your readers a great disservice by recommending this stock!

  • Report this Comment On April 19, 2010, at 1:17 AM, damonwatson wrote:

    I really wish paypal was a seperate company and ebay was really put on display for all to see...I too think paypal is the only reason people are saying its stock will run into the $30's... because ebay is agressively pushing its sellers out the door, and its these sellers that help it attain such high returns...ebay really believes money is made by the buyers, when in reality the sellers always pay the bill...

  • Report this Comment On April 19, 2010, at 6:35 PM, BigHackAttack wrote:

    Oh man, it's so easy to spot disgruntled eBay Sellers. They're the ones who mindlessly dismiss the fact that eBay is a spectacular cash machine and instead bemoan what they perceive as ill treatment or arrogance from eBay execs.

    Accept it: You weren't able to adapt to eBay's new ground rules that favor Sellers who consistently make buying on eBay an overwhelmingly positive experience.

    Sure, eBay pushed you away; it was by design. They actually make more money WITHOUT you, because you're not scaring the Buyers away any more.

    I'd offer you some grapes, but I'm all out of the sour ones.

  • Report this Comment On April 19, 2010, at 8:52 PM, tkell31 wrote:

    Is it me or are some of the people who comment too dumb to get the point? Instead of focusing on the the stock highlighted, exc for the morons out there, and the point of the article they focus on one stock referenced in the article.

  • Report this Comment On April 19, 2010, at 11:12 PM, bigkansasfool wrote:

    Good general article about value investing, HORRIBLE Stock picks. Exelon is trading very close (if not above) it's intrinsic value. I'm having a hard time finding anywhere to put my cash right now, and my cash position is growing steadily. This time last year I was jumping in, and now I'm moving to more cash and can't find anywhere to put it. This historic swing upward has dragged everything up with it and I've only found 3 stocks that I'd call values in the last 2 months. If GS gets trashed more, I might be considering that, but otherwise I'll wait for a correction.

  • Report this Comment On April 20, 2010, at 9:48 AM, TMFPhillyDot wrote:

    @bigkansasfool,

    thanks for the comment. Interesting that you think Exelon is trading at intrinsic value. We have it trading almost 37% below it's true worth. Would be curious about what assumptions you used in your model.

    Anyway, thanks for actually responding to the stock I was talking about!

    Foolishly,

    Jordan (TMFPhillyDot)

  • Report this Comment On April 20, 2010, at 11:12 AM, KZMike wrote:

    Take a look at preferred stocks. . . yesterday I purchased Archer Daniel 'preferred A' [Scottrade symbol ADMpA]. Its call price is $50 is now selling for about $40 and is yielding near 8%. Bank of America has some preferred issues as well as some others. Maybe dull and boring but a good place to park cash.

  • Report this Comment On April 21, 2010, at 11:23 PM, TheDumbMoney wrote:

    TMFPhillyDot, good question to bigkansasfool, but your article also fails to mention how the Fool finds EXC is 37% below its true worth. What assumptions? What model(s)? Pure discounted cash flow model? A blend of models? I realize these articles are all a tease, but I'd love to see a *bit* more on the spotlighted stock. Also, a five year average for P/E is too short; I like Morningstar's feature where you can look at ten years. I'm an EXC fan, btw. I like it's position in nuclear, as a story. But I also like its 15+% profit margin as a utility, and its general cash flow growth over the past ten years -- acheived without increasing (and in fact I think even reducing) total debt. On the other hand, I don't think it has grown its shareholder equity very well, per dollar of retained earnings, but that is just something I vaguely remember, and not a calculation I often make or know tons about.

  • Report this Comment On April 21, 2010, at 11:37 PM, SUPERMANSTOCKS wrote:

    What I want to know is why Motley Fool continuously pumps and or promotes the stocks listed in the article? Why can't they talk about smething other than Apple or GE? I like making money. But If I wanted own something I would place in my IRA and forget. I would buy these companies.

  • Report this Comment On April 21, 2010, at 11:45 PM, stan8331 wrote:

    The way I look at it, EXC would be a solid utility stock without the nuclear angle. Strong dividend at a low payout ratio, good revenue, good gross margin, fairly low P/E. Adding in nuclear offers a growth opportunity that makes the company look very attractive to me. And even if nuclear somehow fails to provide added growth, you still own a good utility that pays a very respectable dividend.

  • Report this Comment On April 22, 2010, at 12:01 AM, TheDumbMoney wrote:

    Supermanstocks, every day I wonder whether I'm making a mistake by not buying Apple, despite its share appraisal apreciation. I fretted at $100/share. I fretted at $150/share. I fretted at $200/share. I don't blame the Fool for mentioning it often. It's a phenomenal innovator and a major, major revenue growth and cash flow growth story. It has goodwill and pricing power out the wazoo. As my horizon is long term, the main thing holding me back is the fact that Steve Jobs is not immortal. Apple showed over a decade ago how dependent it is upon Jobs. Very. The man has already had a liver transplant. He might live twenty more years, but he might be gone next year. Where is the succession plan? Who else could make the wheels spin? There's too much uncertainty in the five-to-ten year horizon. Still....

  • Report this Comment On April 22, 2010, at 6:20 PM, mvegask wrote:

    TOO much verbuage.

    Lets reduce it to B,H,or S.

    Thanks

    Mel

  • Report this Comment On April 29, 2010, at 6:55 PM, puckfan7 wrote:

    Thanks for you comment Mel,

    "Verbuage" is NOT a word. Superman, I'm thinking just like you. Obviously...The Fool wants to make money....Don't we ALL? However, I'm ALSO sick and tired of hearing of the same old companies. It seems that these "buys" are day trades, at best. Apple will only exist until our nation goes into debt....OOPS....That's right....We're already into debt. TRUST ME....

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