Three Cheap U.S. Stocks with Huge Profit Potential
Bargain-hunting investors this year have been able to feast from a market buffet of cheap U.S. stocks.
Reports have surfaced in the past few months about how the Standard & Poor's 500 is offering the lowest-priced stocks in years based on price/earnings ratios.
Bloomberg in March reported that companies in the S&P 500 were trading at 14.1 times earnings, the lowest valuation of all 34 peak periods since 1989.
Then in May former U.S. Federal Reserve Chairman Alan Greenspan declared that "stocks are very cheap."
Again just last week Bloomberg noted that the S&P 500 is trading 16% below its average valuation since the 1950s.
Now, after the S&P 500 recorded its best June since 1999, investors want to know if it's still the time to buy or if the party's over. With the Eurozone debt crisis still looming and a spate of recent gloomy U.S. economic reports, market optimism has thinned.
But there are still bargains to buy.
How to Find Cheap U.S. StocksFirst, to determine if a stock is undervalued with high profit potential, and not cheap and going nowhere, investors need to scrutinize the driving factors of why a stock's price has fallen.
For instance, you must look at what's happening to the stock's sector - is there a macroeconomic or cyclical reason for the stocks to slip?
Then look at the company - is it in healthy financial shape? What are its future prospects?
Some stocks like Bank of America (NYSE: BAC) may seem undervalued when looking at tangible value, which tells us BAC is worth almost double what it is trading at now. But the company posted negative earnings per share last quarter. Analysts expect it to post a positive EPS of 16 cents this quarter and give it a forward P/E just above 8, which is cheap - but it's a stock that comes with a lot of volatility, so its low price is risky.
Others have had a long slide and may be at a bottom, such as tech struggler Hewlett Packard (Nasdaq: HPQ). CEO Meg Whitman is trying to turn the company around, but HP has lost more than half of its market value over the past year. With its forward P/E less than 5 it seems like a bargain, but there isn't a strong case for why this stock could rally.
And finally look at General Motors (NYSE: GM) or Ford Motor Co. (NYSE: F). Both currently have P/E ratios below 6 and even though the auto industry has been one of the hardest hit U.S. sectors over the past few years it looks to be on the upswing now.
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Dow Jones Erases 2012 Gains – What's Next?
The "sell in May and go away" approach panned out this year as the month was not merry for markets.
U.S. equities experienced a steep drop during May, enduring the worst monthly declines in two years. The Dow Jones Industrial Average fell 6.2%.
A good part of May's decline was blamed on the ongoing European sovereign debt crisis that has swelled of late and shattered investors' confidence. But things on the home front are far from ideal.
The flight from stocks flowed into the first day of June. The Dow plunged 274 points Friday, erasing all of the year's gains. Fueling Friday's fall was May's dreadful U.S. jobs report, which showed employers added just a trifling 69,000 in payrolls, less than half the expected 150,000.
The Standard & Poor's 500 Index and Nasdaq both plummeted more than 2%. The Nasdaq has given back more than 10% since its late-March peak.
Traders consider a 10% drop to be a market correction. Meanwhile, the S&P 500 is just a mere point above correction territory.
Just 17 of the 500 companies in the S&P index ended higher on Friday.
"The big worry now is that this economic slowdown is widening and accelerating," Sam Stovall, chief equity strategist at market research firm S&P Capital IQ, told the Associated Press.
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The Most Important Investment You Can Make Right Now
I was taken aback by the question: "What is the single most important investment I can make right now?"
Not by the question itself - I get that one a lot.
But because of who was asking it and what they excluded.
It was put to me by Jason, Susan and Hao - all of whom are juniors at Skidmore College where I was lecturing last week.
They wanted to know what they - as college students - could do to ensure their financial future.
Not only that, but they specifically asked me to exclude specific investment choices that a more seasoned, older investor would consider.
I thought about it for a few minutes, then responded: "It's discipline."
Investors are faced with a unique challenge, I explained. Many are not at the mercy of the markets as they believe, but are actually subjected to the whims of the person they see in the mirror every morning.
That's why consistent investment results are often more dependent on behavior than actual performance.
Put another way, investors who "behave" themselves by being disciplined tend to do far better than those who don't.
Beating the Markets Takes Discipline
For example, DALBAR, a Boston-based research firm ,released a 2011 report that showed investors had achieved a mere 41.9% of the S&P 500's performance over the twenty years ended December 31, 2010.
In other words, investors managed to leave a staggering 58.1% on the table.
According to the report, the average investor achieved a mere 3.8% a year versus the 9.1% annualized return of the S&P 500 because they tended to jump in and out of the markets at the worst possible moment depending on their emotions.
This reinforces something I talk about all the time in my presentations around the world - investors lose billions by trying to time their decisions based on nothing more than greed, fear or simple paralysis.
In my opinion, it's why the single biggest investment anyone can make is "discipline."
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What a Little-Known Market Tool Is Telling Us About U.S. Stocks in 2012
If you're a longtime investor, you're no doubt familiar with the Price/Earnings (P/E) ratio - a common measure for valuing the stock market.
But you may not be as familiar with the more-obscure Earnings/Price (E/P) ratio, which some experts refer to as the "earnings yield" on stocks.
If you're not familiar with the earnings yield, it's time to brush up.
While it may be obscure, the E/P ratio is an important tool. It not only tells you stocks' value, it allows you to compare that value to other assets like bonds.
And right now it's telling us a lot about buying U.S. stocks this year.
Basically, the risk/reward in favor of stocks over corporate bonds has never been this high...ever.
Let's take a look.
How to Use the Earnings/Price RatioWe can get a pretty good handle on the value of stocks if we look at the E/P ratio of the Standard & Poor's 500 Index.
In 2010, the earnings for the S&P 500 came in at $83.77. According to Standard & Poor's, the earnings estimates for 2011 are at $97.81 and will climb to $111.73 for 2012.
Taking the 2011 S&P 500 earnings estimate of $97.81 and the current S&P price of about 1,290, you come away with a multiple of 7.5% (97.81/1290). Simply put, this means that the expected earnings of the S&P 500 are 7.5% of the price of the index.
By the same token, if earnings come in at the expected $111.73 in 2012 and stock prices remain the same, the earnings yield jumps to 8.6%.
Why should you care? Because you want a higher rate of return for the risk of investing in stocks when compared to the rate of return of other asset classes.
Generally, the earnings yields of equities are higher than the yield of risk-free treasury bonds, reflecting the additional risk involved with stocks. But right now the difference is extreme, with 10-year government bonds yielding a paltry 2%. Meanwhile, corporate bonds are paying about 5%.
Now let's compare the return on stocks to the rate of inflation.
Over the past 50 years, the average earnings yield for the S&P 500 has outpaced inflation by 2.4%. When the market is above that mark, equities are considered attractive. When it's below, they're expensive.
Subtract the current core inflation rate of 1.5% from the 2011 S&P 500 earnings estimate of 7.5%, and we end up with 6% - well above the 50-year average. Even if we use the 3.4% consumer price index rate, you're left with a difference of 4.1%. Compare that to bond yields and you're still way ahead.
So that's where we are, but how about where we're headed?
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Why We May See a Rally in U.S. Stocks
With so much negative news dominating the headlines, investors can't be blamed for being worried or shying away from stocks. But if you take closer look at the market - specifically the Standard & Poor's 500 index - you might be surprised by what you see.
The S&P 500 is down just 3% year-to-date, and is actually up more than 5% over the past three months. The indexes for China, India, and Brazil, on the other hand, are all down over the past three months. Brazil's market index is down 19% year-to-date, China's is down more than 21% and India's is down more than 24%.
"People don't understand that the S&P 500 has now outperformed the BRIC nations (Brazil, Russia, India and China) for four years," Richard Bernstein, CEO and chief investment officer for Richard Bernstein Advisors, told USA Today. "We are in the very early stages of a resurgence of the U.S. equity markets, and I don't think people are aware of the shift that is going on."
Indeed, many analysts actually think U.S. stocks are cheap right now.
The price/earnings (P/E) ratio for the S&P 500 dropped to 12.8 as of the third quarter of 2011. The historical average for the S&P's P/E is 15, meaning stocks are moderately underpriced.
In fact, the average P/E has been even higher in recent decades. Since 1988 the S&P average P/E has been 19.2 - which translates to a 33% discount for current stock prices.
Four Reasons for a RallyCorporate America has quietly been rebuilding since the financial crisis of 2008, but the constant barrage of bad news - the multiple disasters in Japan in March, budget battles in Washington, concern over the Eurozone debt crisis - has camouflaged much the progress that's been made.
"The pessimism today is actually creating opportunities for investors," Kate Warne, chief investment strategist at Edward Jones, told USA Today. "There are a lot of short-term concerns, a lot of serious risks, but investors really need to keep their eyes on the horizon, because we are also seeing strong fundamentals. And that is what is driving the market longer term."
Analysts have identified several positive signs - in addition to the relatively low S&P 500 P/E ratio - that indicate U.S. stocks are stronger heading into 2012 than many realize:
- Cheaper commodities: The prices for commodities have fallen significantly since the first half of 2011, which should give corporate earnings a boost at least through the first couple of quarters of next year.
- Lean and Mean: The fiscal discipline dictated by the financial crisis of 2008 has helped many companies weather the troubles of 2011. And now many companies are poised to quickly grow profits as soon as worries ease.
- Dividend Increases: Companies that pay dividends have been increasing them, and that should continue. Despite the increases, the overall payout ratio has dipped to 29% from a 50-year average of 45%. Higher dividends mean a higher total return for investors, and provide some insurance against downturns.
- More Buybacks: Buyback activity among U.S. companies rose to $439 billion in 2011 and is expected to rise to $500 billion next year. That sort of money flowing into the stock market helps boost prices.
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We Warned You U.S. Stocks Could Plunge – Here's the Safety Play You Need to Make Now
U.S. stocks reversed course in the final minutes of trading yesterday (Monday) to push the Dow Jones Industrial Average back over 11,000 - but that still wasn't enough to make a dent in the index's 4.8% loss so far this month.
Europe debt fears and dismal economic news have caused the Dow to fall in five of this month's seven trading sessions, each time by more than 100 points.
We warned you September would be a tough market month - several times.
What's more, we showed you how to protect yourself.
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How Bernanke Will Keep a Fire Lit Under Stocks Until Year End – And Which Sectors Will Soar
While many investors have solid reasons to remain concerned about the broader economic picture, there are some market sectors roaring forward that no one can afford to miss - and they will continue to provide profit opportunities thanks to the work of U.S. Federal Reserve Chairman Ben Bernanke.
Stocks rattled around in 295-point range of the Dow Jones Industrial Average over the past five days like pebbles in a maraca, but ended quietly -- a fraction above flat. The big-cap indexes have now posted six of their past seven closes within half a percent, hemmed in by some sort of spooky gravitational pull.
Earnings came in quite a bit better than expected for most major companies, as the cheap dollar has helped overseas sales for Caterpillar Inc. (NYSE: CAT) and McDonald's Corp (NYSE: MCD). Over in the exciting web content space, Netflix Inc. (Nasdaq: NFLX) wowed the crowd with outstanding third-quarter results, logging a sales increase of 31.0% and adding 1.9 million net new customers. That's a lot of new buyers in an economic environment that is supposed to be so terrible that the Federal Reserve thinks unprecedented medicine is required.
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The 10 Most Pressing Questions About the U.S. Economy – And Their Answers
Will the economy lapse into a double-dip recession? What can be done about the soaring U.S. budget deficit? What's next for the stock market?
These are just a few of the tough questions facing investors. And there may be no one better to offer answers, insight, and advice than Money Morning Contributing Editor Shah Gilani.
A retired hedge-fund manger, Gilani has routinely been there to shepherd investors through blinding market uncertainty. He's used his contacts on Wall Street to give Money Morning readers the inside scoop on the collapse of American International Group Inc. (NYSE: AIG), the May 6 "Flash Crash," and most recently the "Mortgagegate" scandal that currently threatens to undermine the fragile U.S. recovery.
Indeed, Gilani has been a tireless advocate for investors and a prescient market maven. That's why Money Morning's editors recently sat down with Gilani to talk about today's most pressing issues and discover what he expects for financial markets in the months and years ahead.
In the partial transcript of that interview below, Gilani discusses why it's a good time to invest in stocks, what steps should be taken to fix the U.S. economy, and whether or not gold prices have peaked.
In short, the U.S. government has failed the public as a matter of course, but there is still a way out of our current economic malaise and ample opportunity for investors to profit.
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Defensive Investing: Covered Calls Increase Cash Flow, Up Protection
Once you get beyond buying puts or calls for purely speculative purposes, no other options strategy is more popular than selling covered calls - and with good reason: Few investment techniques offer more potential benefits with such a low level of risk.
Considered the most conservative of all option plays, this strategy - which basically involves selling (or "writing") one call option for each 100 shares of a stock you own - can be employed for one or more of five distinct purposes:
- To generate a stream of additional income - over and above dividend payments - from individual stocks in your equity portfolio.
- To generate a stream of income from stocks you own that pay no dividends.
- To reduce the effective cost basis of longer-term stock holdings by bringing in option premiums, thus recovering some of the original purchase price.
- To provide a limited hedge against potential losses in portfolio value as a result of overall market pullbacks or cyclical downturns in the prices of specific stocks.
- As an income-producing substitute for a "limit-sell order" - intended to liquidate a stock position when a specific profit target is achieved.
What We Can Learn From The Stock Market Genius That Wall Street Loves to Ignore
Mathematician Benoit B. Mandelbrot, the inventor of fractal geometry, died Oct. 14.
As mathematicians go, Mandelbrot was very likely the best of the last half-century. And that brilliance extended to the financial markets. In fact, his groundbreaking insights into the operations of the stock market could have been used to avert the 2008 crash - had those insights only been heeded.
But Mandelbrot - for all his stock market genius - has been largely ignored by Wall Street.
As investors, let's not make the same mistake.
To understand how to profit from Mandelbrot's insights, please read on... Read More...
Don't Miss Out on the Global Stock Rally
Indices across the world rose last week in what looks to be the beginning of a historic stock rally.The Standard & Poor's 500 Index rose 1.6% last week, while the overseas developed-world large-caps - represented by the Vanguard FTSE All-World ex-US exchange-traded fund (NYSE: VEU) - rose 2.4%.
Meanwhile, the iShares Emerging Markets ETF (NYSE: EEM) rose 1.7%, the iShares FTSE/Xinhua China 25 Index (NYSE: FXI) rose 3%, the iShares MSCI Switzerland Index fund (NYSE: EWL) rose 3%, and the iShares MSCI Australia Index Fund (NYSE: EWA) rose 3.6%.Among our favoried emerging markets and sectors, iShares MSCI Turkey Index Fund (NYSE TUR) blasted 6.5% higher, the Market Vectors Latin American Small Cap Index Fund (NYSE: LATM) rose 3.5% and Market Vectors India Small Cap Index Fund (NYSE: SCIF) rose 2.4%. The SPDR Gold Trust (NYSE: GLD) rose 2.1% and the Market Vectors Junior Gold Miners ETF (NYSE: GDXJ) rose 2.6%.
To find out how you can participate in the global stock rally read on... Read More...
Will the Fed's Spending Drive Stocks Back Up to Their Pre-Lehman Levels?
The Standard & Poor's 500 Index is up more than 10% in the past month, and it finally looks like all of the thin threads of strength we've seen over the past few months are starting to twine together into a single rope that may be strong enough to pull stocks back up to pre-crisis levels.
The key threads are:
- The ECRI Weekly Leading Index has stabilized and turned higher.
- The U.S. Federal Reserve announced that it had made an epic change in its outlook, targeting deflation instead of inflation.
- Emerging markets and commodities are leading other markets higher, as we have seen for two months.
- Demand for stocks has increased while supply has decreased.
The Fed's Actions Are Boosting the Bull Cycle for U.S. Stocks
News from the U.S. Federal Reserve is keeping the bull cycle for U.S. stocks alive and well. Despite investors taking a breather this week, the outlook is good for coming months.
The Standard & Poor's 500 Index fell 0.2% since Monday, while the Nasdaq 100, shown below, fell every day of the past week for a total slippage of 1.5%. The week felt a lot better than that for my subscribers because all but one of our exchange-traded funds (ETF) bets is on overseas stocks, and most rose 1.75% to 4.7%.
So we are exiting the best September since 1939, but it closed very softly for U.S. investors as the most critical earnings season in the past year looms on the horizon.
But to see why there's good news coming, read on... Read More...
Six Stocks That Should be on Every Investor's 'Don't Buy' List
With more than 8,790 publicly traded stocks on U.S. exchanges and another 7,000 or so listed on the OTC Bulletin Board and the pink sheets, it's not particularly difficult to find stocks you wouldn't want to buy. It's not even that hard to find stocks with numbers so bad they're good short-sale candidates.
What's really hard is recognizing companies whose shares seem like they might be bargains, but that actually have subtle or hidden problems. These stocks truly belong your DO NOT BUY list.
A good example is Bank of America Corp. (NYSE: BAC). The financial sector was among the leaders as the market rallied from its July lows, but BAC didn't add much to the advance. In fact, after a brief bounce, it tumbled to a 12-month low of $12.18 on August 30 - a far cry from its October 2007 high of $52.71. Still, it looks like the stock built a solid technical base during the early September market upsurge and could be poised for a breakout if its earnings, due out Oct. 20, beat expectations.