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Stocks: Cheaper Than Ever?

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Even as the stock market has hit multiyear highs recently, stocks still look cheap by many standards. Yet many investors are staying on the sidelines, fearing an imminent end to the three-year-old bull bounce after the market meltdown of 2008 and early 2009. That leaves one key question: Is keeping cash available a smart move or a waste of capital?

The bull argument
A recent article from Bloomberg said that the S&P 500 is almost as cheap as it ever has been compared to bond yields. When you take the S&P 500's earnings and divide it by the current level of the index, you get what's known as an earnings yield. Right now, that yield is 7.1%, and the spread over current 10-year Treasuries is more than 5 percentage points -- its lowest level since the market's bottom in March 2009.

More encouraging for stocks is the fact that companies appear to be starting to funnel more of their cash into capital investment. Having spent years bolstering their balance sheets after finding themselves cash-poor at critical moments during the financial crisis, many companies are finally loosening the purse strings. Now, capital investment is growing at its fastest pace since before the financial crisis. And assuming that the returns on that investment can exceed the 2% or so that Treasuries are earning right now, the benefits should fall through to corporate bottom lines.

Some warning signs
Of course, for every argument, there's a counterargument. One of the biggest, many believe, is that rates in the bond market are artificially low. The Federal Reserve owns more than $1.5 trillion in Treasury notes and bonds on its balance sheet, as well as more than $840 billion more in mortgage-backed securities. That demand is serving to keep rates lower, discouraging saving both among consumers and businesses. When the Fed finally acts to shrink its balance sheet, then rates should naturally rise.

Moreover, on the other hand, earnings have gotten a huge boost in recent years from improvements in productivity and profit margins. Yet with high levels of unemployment, pressure on companies to boost their payrolls could force them to reverse that trend, sacrificing productivity for job gains. That in turn could halt recent earnings growth, pushing earnings yields lower.

Great margins of safety
If you're looking to get money back into the market, cheap valuations for the overall market shouldn't persuade you just to buy an index fund. If you're diligent, you can find even better earnings yields even among blue chip stocks.

For instance, energy companies are priced as though $100 oil will be a fleeting phenomenon. Both Chevron (NYSE: CVX  ) and ConocoPhillips (NYSE: COP  ) carry earnings yields of 12% or better at current levels. Moreover, with Conoco planning to split off its refining division from its core exploration and production business, shares may have a catalyst to advance in the near future -- even if energy prices hit a plateau.

Technology companies are also presenting some attractive values. Corning (NYSE: GLW  ) , for instance, has one of the hottest products in its Gorilla Glass, which many mobile-device makers rely on for durable screens. Yet the stock gives shareholders an earnings yield of 13% right now, pretty much discounting any prospects for future growth.

Finally, automakers look cheap. Despite the obvious challenges of a struggling Europe and a slow recovery in the U.S., both Ford (NYSE: F  ) and General Motors (NYSE: GM  ) have seen recent strength. In particular, with GM having gone through bankruptcy, it's arguably in the best financial condition in years -- yet investors are still treating it with the same kid gloves they did before its massive restructuring.

Be smart
Stocks may look cheaper than ever by some metrics, but that doesn't mean that you can afford to buy just any stock. By looking for even better bargains, you can give yourself a margin of safety that could help prevent big losses in case the current bull run comes to an abrupt end.

If you're truly a long-term investor, then finding smart stocks has even larger benefits. To get some smart investment ideas, check out The Motley Fool's latest special report. We highlight three smart stock picks for retirement investors, and we won't charge you anything at all for it -- but it won't be around forever, so read it today while it's still available.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter here.

Fool contributor Dan Caplinger rarely looks a gift horse in the mouth. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Corning and Ford. Motley Fool newsletter services have recommended buying shares of Corning, Chevron, General Motors, and Ford, as well as creating a synthetic long position in Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is of the finest quality.


Read/Post Comments (10) | Recommend This Article (49)

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 February 22, 2012, at 5:59 PM, bbrriilliiaanntt wrote:

    Important to remember, as you stated, that interest rates have no where to go but up, period. The risk on owning bonds is considerable, and as folks start seeing their bond funds lose principle, guess where they are going. I will GUARANTEE that Stocks outperform Bonds over the rest of this decade...

  • Report this Comment On February 23, 2012, at 2:03 AM, PeakOilBill wrote:

    The days of cheap oil are over. The super majors will make fortunes. Put some money in Chevron, Conoco, Exxon, Total, BP and Shell. LNG for large trucks will soon take off inside the USA. They use a LOT of fuel. Even railroads are looking at LNG instead of higher and higher priced diesel.

  • Report this Comment On February 23, 2012, at 7:45 AM, clbjblk wrote:

    GSFVF hurry

  • Report this Comment On February 23, 2012, at 9:36 AM, ETFsRule wrote:

    Agree 100% with bbrriilliiaanntt. Stocks are the only investment that makes sense right now.

  • Report this Comment On February 23, 2012, at 11:05 AM, oldman144 wrote:

    An old but true saying is "Those who forget the errors of the past are bound to repeat them.." As far as cash goes- keep plenty around and invest with great caution.. Europe is still a basket case, Iran has more influence than we care to admit and $4 plus gas will put the brakes on shopping and spending in a traditional way although AMZN might really get a shot in the arm..

    As a geezer investor I have seen more down markets than up. Sure wish I had a crystal ball.

  • Report this Comment On February 23, 2012, at 11:34 AM, Callsandputs wrote:

    Ford is the stock pick and I liked it all the way up from 2008. It's a Buy. Their F150 truck is the "bomb" owning the road every year in truck sales. If they fix the fires in the VOLT it just might be a winner. American's still love big and fast cars. $5 a gallon gas doesn't scare Ameican's like it once did.The Lincoln Continental sells out every year. Ford is headed back to $18 and might hit $20 this year.

  • Report this Comment On February 25, 2012, at 3:00 AM, stevec5792 wrote:

    Callsandputs, you do know the VOLT is GM, right? :) If GM fixes the Volt how does that affect Ford?

    My Ford Escape with 4-cyl, traditional gasoline, a few options...gets 26.5 MPG on almost all short distance driving. That's a far cry better than my Bronco II at ~20 MPG with the same habits. The F-150 is a remarkable truck...wish I had one but the wife says "no" because she's too short to get into it. :(

    I also agree with bbrriilliiaanntt and ETFsRule, which scares me a little bit. I cannot imagine a situation where bonds outshine stocks over the next 10 years. But, are we in for a big fall because everyone is piling back in? I don't know, but I'm 95% in the market and plan on staying that way. :)

    Lastly, oldman144, in the last 30 years, the markets are up MUCH more than they are down...unless you believe in the philosophy of "Buy High and Sell Low". If you would simply hold shares in quality companies through all of the "bad" times, you'd be a wealthy man by now. :) I wish I had, but I've been learning. All you had to do was hold these 5 stocks: Apple, Microsoft, Enron, Worldcom and Delta Airlines. 100 shares of each bought 30 years ago and held throughout, you'd be a 1%er. :) I hope you notice the 3 Bankrupt companies, btw. :)

  • Report this Comment On February 25, 2012, at 1:13 PM, ChrisBern wrote:

    Only comparing stocks to bonds is a bit of a straw man. One should compare stocks to bonds, real estate, and doing nothing. In certain markets, real estate (rental property) is currently the best investment. Doing nothing is the universal best option right now though, since almost all asset classes are WAY overpriced for their level of risk. There will be great buying opportunities once the global recession hits the U.S. and stocks fall 20-40% from current levels. Doing nothing in the meantime will ensure there is dry powder available to buy up the bargains.

  • Report this Comment On February 26, 2012, at 2:51 AM, lowmaple wrote:

    stevec# some people made money on Worlcom in addition to the winners. They did that of course by selling after they got to outrageous valuations. Just like they did with Netflix last year.

  • Report this Comment On February 29, 2012, at 4:16 PM, hbofbyu wrote:

    @chrisBern

    Whenever someone makes a prediction I expect the opposite to happen. Things just never seem to play out the way we expect.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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