I've been in the investing business a long time. I've witnessed two nasty bear markets and three exuberant bull markets. As a broker, trading analyst and financial journalist, I've seen, heard, and done it all (most if it more than once). At this point in my career, I never expected to see anything I hadn't seen already.
Well, I was wrong.
For the first time in my adult/professional life, I'm witnessing a stock market that's as undervalued -- on a trailing earnings basis -- as it's been in 20 years.
Uncharted Value
Most of the time, most stocks trade in the middle of their lifetime averages.
Whether you're talking about the price-to-earnings ratio (P/E), net profit margin or earnings growth, over time, most of the metrics we use to measure value stick within their long-term ranges.
[If you're new to this type of analysis, check out our educational features What Is the Real P/E Ratio for the S&P 500, 15 Financial Ratios Every Investor Should Use and Financial Statement Analysis for Beginners.]
But when we start to see values and ratios we've never seen before, this is usually the beginning of a huge opportunity (or a massive disaster). You just have to be smart enough to recognize it and react.
Case in point: Back in the middle of 1999, the S&P 500 was priced at a record 29 times trailing earnings, far above its long-term average. Less than a year later, this excessive overvaluation destroyed the folks who jumped into the bubble right before it burst.
Now the fear/greed pendulum has swung too far in the other direction. On August 24th, the S&P 500's P/E ratio hit [12.3] times its trailing 12-month earnings. If the number itself doesn't mean much to you, let me tell you that the market hasn't been that 'cheap' since the late1980s.
It's not just the overall market that's in bargain territory right now. Wal-Mart (NYSE: WMT) shares hover below a P/E ratio of 12, even though they posted record-breaking earnings. Microsoft's (Nasdaq: MSFT) P/E is bouncing between 8.6 and 9.6, but like Wal-Mart, it just posted record-breaking 12-month earnings (trumping the theory that Microsoft is a has-been). Even Campbell's Soup (NYSE: CPB) -- one of the most defensive, recession-proof names out there -- hit its lowest P/E in more than a decade. In early August, the stock priced at 12.4 times trailing 12-month earnings, even though (you guessed it) Campbell's Soup recently reached record-breaking earnings levels.
And it's the massive underpricing of Campbell's Soup shares that really leads to me to conclude that the collective market is simply overreacting to a little bad economic news, selling anything and everything in sight regardless of any value, perceived or otherwise.
More Talk Than Substance
I know my 'glass half full' point of view puts me in the minority. Most analysts and commentators are working hard to convince investors that stocks are doomed because we're headed back into recession. And, I understand their arguments. I just don't agree with them, for a couple of reasons.
It would be naive to think the economy is fine. At the same time, it would be short-sighted to assume we're back in a recession, since there's no actual evidence of economic contraction yet. While growth may be slow (and even slowing), it's still growth.
Now, if you disagree and see the economy already on the slide, I'm not going to try and talk you out of that today. Let's just agree to disagree so we can continue the dialogue.
I will ask you one not-so-hypothetical question just to get you thinking: Is it at least possible the surprising onset of the recessions in 2000 and 2007 might be causing an instinctual, reflexive response to even the slightest hint of trouble now?
And what about the terrifying prospects being batted around on financial news television?
I'll let you in on a little secret -- networks love to trumpet disaster because fear draws a crowd and increases ratings. Take a closer look at Nouriel Roubini and Robert Prechter's outlooks and comments from early 2009. They were bears then, too, right in front of major bullish events. These gloom-and-doomers are always given a bigger platform when it feels like they might be right.
[InvestingAnswers Feature: The 6 People Who Owe Their Fame to the Recession]
The Investing Answer: There's an old Wall Street adage: 'Economists have predicted nine of the last five recessions.' It's funny because it's true. All of the errant predictions seem to make perfect sense at the time.
Now take a step back and really absorb how the overall market and many individual stocks are literally cheaper than they've been in decades. When you start seeing once-in-an-era low valuations while earnings are still on the rise, then you have to work through the fear and be willing to do what most others aren't.
Photo courtesy of freefoto.com.
