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Beating Back The Bubble Babble

Jan 6 2014, 7:36am CST | by

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Beating Back The Bubble Babble

WITH STOCKS AT or near alltime highs, financial publications and market pundits are providing plenty of hot air as they inflate a bubble by talking about a stock market bubble. All of that chatter is a plus from a contrarian perspective, even as valuations on the major U.S. equity market averages are near the high end of their historical ranges. The trailing-12-month P/E ratio of 25.5 on the S&P 600 Index (small caps) and 23.3 on the S&P 400 Index (midcaps) are well above median end-of-year P/E ratios dating back to 1995 of 21.9 and 20.9. Compared with the relative richness of smaller stocks’ valuations, large caps still look cheap. The S&P 500 now trades at 16.9 times earnings, which is actually below the 19-year median of 18.3, while the current dividend yield of 1.93% is higher than the 1.80% median.

Even at current prices, I’m still finding attractive stocks. There are certainly many growth stocks trading for rich valuations, but the beauty of active portfolio management is that you don’t need to own them. For instance, if you look at the S&P 500 you see that one of its most popular components is Netflix, the video subscription service, which trades for more than 300 times earnings.

Sometimes stocks do grow into their multiples, but I find Netflix hard to justify at these levels. Something much easier to digest is the modest valuation of a world-class franchise like APPLE (AAPL, 545), which trades for 14 times earnings and also rewards shareholders with a healthy 2.1% dividend yield. Believe it or not, if Apple were awarded the same earnings multiple as Netflix, the consumer electronics superstar would change hands at nearly $12,000 per share.

Plump multiples also abound among the various S&P 500 travel-booking websites. Expedia, Priceline and TripAdvisor all trade for more than 30 times earnings. Unlike many tech startups that have recently gone public, each of these companies actually makes a profit, but there are much less expensive stocks in the technology sector, especially among its largest members. For example, networking equipment company CISCO SYSTEMS (CSCO, 21), software king MICROSOFT (MSFT, 36), microchip titan INTEL (INTC, 25) and IT solutions provider IBM (IBM, 180) all trade for about 4 times earnings while also providing dividend payouts well above that of the S&P 500. In the case of Intel, you’re looking at a generous 3.6% yield.

The list of inexpensive large-cap companies in the S&P 500 is not only limited to the tech sector. I’m a fan of stocks in the capital goods sector like agricultural equipment maker DEERE & CO. (DE, 89) and construction equipment concern CATERPILLAR (CAT, 88), two names that also offer low earnings multiples and rich dividend payouts.

And the commodities space has bargain stocks, including oil driller ENSCO (ESV, 56), which trades for less than 11 times earnings and yields 4%, and mining and energy conglomerate FREEPORT-MCMORAN COPPER & GOLD (FCX, 35), which sports a P/E of 12 and a dividend payout of 3.6%. Rounding out my baker’s dozen of undervalued stocks are retailer KOHL’S (KSS, 55), utility operator ENTERGY (ETR, 62), medical device maker BAXTER INTERNATIONAL (BAX, 67) and banking giant WELLS FARGO (WFC, 45), nearly all of which boast below-average P/E ratios and above-average dividend yields.

Keep in mind that even as the Federal Reserve tapers its bond-buying program, interest rates are still near historic lows, with
money market funds yielding 0.01% on average today, compared with 4.5% at prior market peaks in 2000 and 2007./>

This fact, along with the inexpensive valuations of my holdings, abates any worries that I may have about a bubble in stocks. Don’t be dissuaded by the strong performance of the past year. Cheap stocks are still out there.

Source: Forbes


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