In normal times, an unemployment figure hovering within spitting distance of 10% would be bad news indeed. These are far from normal times, of course, and the stock market has been defying the laws of economic gravity for a while now. It's shot up sharply, even though nearly a tenth of the available workforce has no work. Indeed, the S&P 500 has tacked on more than 50% since its March lows.
Cash for clunkers
The rally has been especially kind to seemingly vulnerable stocks such as Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS). Both have pole-vaulted to triple-digit gains on a year-to-date basis, despite dodgy financial health and exposure to the slings and arrows of a still-outrageous financial sector. Toxic assets haven't evaporated, after all, and the feds have been scrutinizing Bank of America's acquisition of Merrill Lynch for signs of criminality.
Meanwhile, the charts of Amazon (NASDAQ:AMZN) and Intel (NASDAQ:INTC) demonstrate similarly suspect trajectories. Make no mistake: These companies are far stronger than the likes of Goldman and Morgan Stanley, in my view. Nonetheless, they now sport multiples that look fat and unhappy: Both trade at more than 40 times current earnings.
If the recovery isn't as robust as the market seems to think it will be, stocks with aggressive valuation profiles such as these may take a hard hit. That's also true of high-flying Visa (NYSE:V), which trades with a P/E near 40 despite the fact that its fortunes are basically tethered to the economic cycle via consumer spending -- and the level of consumer default.
Meanwhile, at the other end of the valuation spectrum ....
ConocoPhillips (NYSE:COP) and Chevron (NYSE:CVX) may not appear as richly valued -- in fact, the former is sporting a negative P/E. Still, following substantial price pops over the last quarter, are these companies values or value traps? Both are deep cyclicals whose fortunes will rise or fall with demand for a highly volatile commodity.
Dialing for dollars
During these strange days, you may be surprised to learn that I have my eye on Sprint Nextel, which is up about 75% on a year-to-date basis.
Rocked hard amid the downturn, Sprint last paid a dividend in 2007, and it has posted negative net income during each of its past two fiscal years. At a glance, the company looks similar to the stocks I "trash-talked" above. Yet one Fool's trash is another's treasure -- and Sprint looks like a diamond in the rough to yours truly.
At some level, after all, even flailing companies can make attractive investment prospects. Sprint isn't exactly flailing: It raked in more than $35 billion in revenue during fiscal 2008, netting out a gross profit of nearly $19 billion, and the company has been free-cash-flow (FCF) positive during eight of the past nine years. The sole miss occurred way back in 2001, and the past 12 months have seen a sharp FCF increase compared with 2008.
On the risk side of the ledger, I'm troubled by the company's recent debt offering. Yet even after factoring this fresh development into the analysis, Sprint appears to be trading at a steep discount to fair value. Indeed, using a normalized free cash flow figure and conservative estimates of earnings growth that account for Sprint's third-place status in a race that includes Verizon and AT&T, my back-of-the-envelope valuation for the company comes in at roughly $7.50 a share. As I type, Sprint trades near $3.20.
About that envelope
I didn't actually use one. I used the discounted cash flow (DCF) calculator that comes gratis with the Fool's Inside Value service. With pointers to the data you need, this no-muss, no-fuss tool comes in handy indeed when winnowing a field of contenders down to just those that appear worthy of further research.
And if you'd rather leave that work to others, not to worry: In addition to resources like the DCF tool, members have complete access to all of Inside Value's recommendations. Each comes with "buy-below" guidance -- the price below which our advisors feel the stock is a strong buy. That way, you'll know amid these strange and volatile days whether a recommended stock's price remains right. If you think you'd like to give our picks a try, click here to grab a completely free 30-day guest pass to a service designed to help you invest like an adult. There's no obligation to stick around if you find it's not for you.
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This article was originally published Aug. 19, 2009. It has been updated.
Shannon Zimmerman runs point on the Fool's Duke Street and Ready-Made Millionaire services, and he runs off at the mouth each week on Motley Fool Money, the Fool's fast 'n' furious podcast. A fresh edition of MFM hits iTunes each Friday, and you can listen by clicking here. (Link opens iTunes.) Shannon doesn't own any of the companies mentioned in this article. Sprint Nextel and Intel are Motley Fool Inside Value recommendations. Amazon.com is a Stock Advisor pick. You can check out the Fool's strict disclosure policy right here.
