Are Stocks Too Cheap to Pass Up?

The headline from Bloomberg earlier in the week was simple and to the point: "Stocks Cheapest in 26 Years Amid Rising Profits." In short, when you combine the S&P 500's drop since late April with the expectation that corporate profits will continue to rise, you end up with valuations that are lower than we've seen in a long time.

Here are a few of the tasty numbers Bloomberg noted:

• "Even if companies posted no growth, price-earnings ratios would be lower than 96 percent of days in the past two decades."
• "Losses since April have pushed the price of the S&P 500 to 14.5 times the past year's earnings, compared with the average 20.5 since June 1991…"
• "The gauge [i.e. the S&P 500] is priced at 8.7 times cash flow, cheaper than in 81 percent of occasions since 1998."
• "The gauge is priced at 2.1 times book value … lower than it has traded 90 percent of the time since 1995."
• "Should stocks stay at current prices and the analyst prediction come true, the S&P 500 would trade at 12.8 times income on Dec. 31, the lowest level since 1985 except for the six months after Lehman Brothers Holdings Inc.’s bankruptcy in September 2008 and nine months in the late 1980s, according to Bloomberg data."

That all sounds pretty convincing. Is it time for investors who have been hanging onto cash to start throwing it at stocks?

On the one hand …
I'm not all that impressed. The idea that current valuations present a great buying opportunity rests on the idea that the past 20 or so years is a meaningful time period to use as a comparison. I'm not so sure that's the case.

Yale's Robert Shiller maintains a spreadsheet with more than a century's worth of stock market price and earnings data and he tracks a measure called the cyclically adjusted price-to-earnings ratio (affectionately known as CAPE). This is simply the current S&P 500 price divided by the average earnings over the past decade, and is meant to capture average earnings power of the index over both the ups and downs of economic cycles.

That CAPE figure currently sits at about 21.7 versus a long-term average of 16.4. Furthermore, when we look at the past 20 years, it's pretty obvious that it's been a period of exceptionally high valuations.

Source: Irrationalexuberance.com. Author's calculations.

In case you're concerned that the CAPE somehow produces wacky numbers, I'll note that though the numbers for the one-year averages are slightly different, the pattern is exactly the same.

On the other hand …
The S&P 500 is a broad measure that covers 500 stocks; just because it doesn't look unquestionably cheap, that doesn't mean there aren't individual stocks well worth buying right now. So I looked for stocks that trade at a forward multiple below that of the S&P and pay a better dividend than the index. The former should be obvious given the discussion above, while the latter ensures that we get a better-than-average cash return even if prices don't increase immediately (plus, don't tell anybody, but dividend stocks are simply better stocks).

Here are a few that I came up with.

Source: Capital IQ, a Standard & Poor's company.

I don't want to give the impression that these are perfectly obvious open-and-shut buys. The market's concerns about these companies have helped depress their stock prices.

At Pfizer, the patent-expiration reaper is hanging around just waiting to cut off the company's protected position on major drugs like Celebrex and Viagra. Intel may be the king of PC chips, but investors are concerned that the era of mobile will knock Intel off its high horse as smaller competitors like ARM Holdings (Nasdaq: ARMH) continue to dominate the market. Thanks to its consistent and impressive historical performance, Aflac was picked as an "incredible dividend stock" by my fellow Fool Jacob Roche. However, investors have been a little wary about Aflac of late because of the situation in Japan, which is where Aflac gets the bulk of its business.

Analysts are looking for a big jump in Whirlpool's earnings in 2011, but investors may not be able to expect much for at least a couple of years after that, as 2013 earnings per share are seen coming in below 2011's. Finally, Albertson's owner SUPERVALU has been working to get its financial house in order, but investors may still be leery of the company's considerable debt load and the impairment-driven losses it's reported in recent years.

However, in all of the cases above, I think the market may have put an excessive markdown on these stocks and made them more attractive values than the market as a whole.

Of course, these aren't the only attractive opportunities in today's market. My fellow Fools have put together a special report that looks at a baker's dozen of additional ideas that also treat their shareholders to dividends. You can find out the "13 High-Yielding Stocks to Buy Today" by grabbing the special report for free.