Searching for value in this market isn't exactly like finding a needle in a haystack yet. But, as stock prices continue to soar, it's increasingly hard to know which stocks represent compelling values. Part of the problem is that while consumers are still battling sluggish retail sales and last year's record job losses, the investing environment remains relatively strong.
I spoke with one big bank trader recently who pointed out that if there is any kind of bubble forming in the market, it is a cash one. For the year ended in June, all American companies, public and private, reported $1.5 trillion in cash flow. That's the highest rate ever, relative to interest costs. As a consequence, the ratio of cash to share prices is forecast to reach a two-decade high next year.
That rationale has led a number of analysts to point out that investors ought to be overweight in small caps and riskier shares, as opposed to more defensive investments. And so after a strong year, some great quality companies are now beginning to lag key indexes, as investors have bid up otherwise riskier companies.
But while there is likely to be a wave of mergers and acquisitions at some point in 2010, it would be a big mistake to overlook the non-cyclical large caps. The global economy is still far from firing on all cylinders, and any sudden shocks could easily lead to another quarter or two of earnings stagnation, or even declines for many companies.
Companies such as Procter & Gamble
On a one-year or even five-year basis, though, an investment averaged over these four companies is outpacing the S&P significantly, which is still down since the Lehman Brothers debacle last year.
Move to greener pastures
With a potential wave of acquisitions next year, there may be a surge in the price of small-cap biotechnology, Internet, and clean-fuel companies, but the larger companies will also do well with the deals. Growth spurred by acquisitions could help cash-rich companies to significantly outperform the market.
Some of these so-called defensive companies are already penetrating growth industries. For instance, Procter & Gamble is ramping up its e-commerce business to capture online the millions of potential buyers of its supermarket-style range of packaged goods.
And it's a similar story of innovation for Johnson & Johnson. As poppycock2, one of more than 140,000 Motley Fools CAPS members, recently pointed out: "[It's] been around many years, [has] solid management, plenty of cash to buy Biotech companies with promising drugs, sell things people actually need and use, pays a solid dividend which over time will help you build wealth." In fact, stem-cell research is a major focal area for the company.
As for Microsoft, I know that lots of investors are mad about Apple
If you're not a fan of these four dividend-paying, consistent hitters, there are lots of others out there. Here's another example: In the midst of the Cadbury buyout speculation, Kraft Foods has taken a beating. But when you look at the company's long-term ability to generate earnings, it's hard to see how, at less than 19 times earnings, the company is not undervalued.
The greater point here is that, as investors rush to bid up the more volatile names for quick short-term returns, don't overlook the obvious value. For sure, speculative bets such as Sirius XM Radio
Johnson & Johnson, Coca-Cola, and Procter & Gamble are Motley Fool Income Investor selections. Google is a Rule Breakers selection and Apple is a Stock Advisor pick. Coca-Cola and Microsoft are Inside Value picks. The Fool owns shares of Procter & Gamble. Try any of our Foolish newsletters today, free for 30 days.