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The stock market has been on an almost uninterrupted tear since the market meltdown reached its worst in March 2009. But with stocks having doubled from their lows just two years ago, some investors are getting increasingly nervous about staying fully invested -- just as many who missed much of the rally are getting up the nerves to get back into stocks.
At times like these, value investing strategies have a lot of appeal. Having earned great returns from the market lows, you don't necessarily need huge future gains as much as you need to protect the profits you already have. Rather than just jumping into the obvious popular value plays, however, a little extra digging can uncover even better bargains.
What's next for the market?
Although we all know where the market has been, where it's headed next is the subject of a huge debate. On one hand, bulls argue that the rally can continue, with Goldman Sachs looking for the S&P 500 index to hit 1500 by the end of the year. To bulls, the combination of low interest rates and increasing earnings among large-cap companies makes stocks generally look undervalued.
On the other hand, bears see trouble ahead. Well-regarded money manager Jeremy Grantham argues that the market is living on borrowed time. He says that if Goldman's prediction of 1500 for the S&P comes true, it would represent not a new bull market but rather just the latest in the series of asset bubbles that financial markets have seen since 2000.
Despite their disagreement, both camps can probably agree on one thing: Sticking with stocks that trade at reasonable valuations and a discount to their intrinsic values is a smart thing to do right now.
Value will be back
That hasn't been a popular strategy lately. Throughout the rally from 2009's lows, small-cap stocks have outpaced their larger competitors, as taking risk has been rewarded with surprisingly large return advantages.
But as uncertainty increases, value stocks give you potential gains no matter what the overall market does. So even though Grantham isn't optimistic in the long run, the funds he manages own shares of megacap favorites Wal-Mart (NYSE: WMT ) , Coca-Cola (NYSE: KO ) , and Chevron (NYSE: CVX ) , each of which has a low P/E multiple and a good track record of outperforming the broader market during the most recent stock market declines.
In fact, among the biggest components of the S&P 500, you'll find a number of stocks that have low multiples. But you might want to look beyond the limelight to find the best value stocks.
Staying clear of turbulence
Looking for value stocks that are still big but not immense makes sense for a number of reasons. Foremost is the fact that value investors gravitate toward megacap stocks for their perceived safety and stability.
But that can leave other bargains virtually untouched. For instance, Lorillard (NYSE: LO ) isn't as well-known as tobacco peer Altria, but Lorillard carries a higher dividend at cheaper earnings multiple. In the defense industry, Northrop Grumman (NYSE: NOC ) and Raytheon (NYSE: RTN ) don't have the same presence as Boeing, but they've been beaten down to much lower valuations than their larger rival despite having similar growth potential. And Limited Brands (NYSE: LTD ) may not have the discount focus of a Wal-Mart, but its Victoria's Secret and Bath & Body Works franchises have been producing solid growth in its most recent quarter -- and the company's shares fetch only a slightly higher multiple for much faster future growth.
Of course, if a bear market comes, then you can't necessarily count on even the most attractively valued stocks to hold up. The question, though, is which stocks will help you avoid the most damage. Stocks that already trade at a discount to their industry peers stand a better chance of avoiding the biggest losses.
Take the road less traveled
Many investors think that when you're looking for hidden treasure, you have to stay completely out of the spotlight. But sometimes, good values hide right under your fingertips. Often, all it takes is the tiniest amount of effort to go beyond the headline stocks in each industry to find the best prospects for value.
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