The world is ending, so run for the hills, buy gold and stash your money under the mattress. We are headed for a financial apocalypse.
That’s what headlines from the past couple of weeks are saying. Here are some examples:
“Shiller Sees ‘Substantial’ Probability of Recession”
“Nearly Half of U.S. Think New Recession Is Coming: Poll”
“We’re on the Verge of a Great, Great Depression. — Peter Yastrow”
What’s everyone so worried about? Jobs, housing, consumer confidence, Greece … the list goes on.
But the pundits are ignoring one big fact: Corporate America is alive and well.
I would agree that the recovery in housing will take longer than expected, and that U.S. economic growth will be choppy the next several quarters. If we look at valuations and the balance sheets for U.S. companies, we see there are opportunities ahead.
While it’s important to stay on top of the economy and keep track of the various indicators and metrics, when I see an increasing level of bearishness, it’s a signal that it might be time to put some money to work. And with the S&P 500 down 7% from a high in April, the opportunities are even more attractive.
Never mind the negative headlines, here are the positives:
Stocks, on a trailing basis, look reasonable, trading at 14.5 times 12-month earnings for the S&P 500. The 39-year average is 16.3, representing a 12.6% discount. On a forward-looking basis, things are even better, with the S&P 500 trading at 13 times 2011 estimates (of $98), and just 11.4 times 2012 estimates (of $112). If the $112 estimates for next year prove to be accurate, assuming a conservative 13 times forward price-to-earnings multiple, the S&P 500 could be worth 1,456 (14% upside from here).
And profits continue to impress. In the first quarter, earnings were up 17% from a year earlier, with margins increasing to 9.4%, up sharply from 8.7% a year earlier and 8.9% in the fourth quarter. And, according to Zack’s research, analyst revision ratios (the ratio of positive earnings revisions over earnings cuts) are at 1.42 for 2011 and 2.67 for 2012 — both bullish levels.
So what areas of the market look attractive? I’d stick with large caps. According to Bank of America/Merrill Lynch research, the gap in forward P/E between the Russell 2000 and the Russell 1000 is at 3.8 times, close to an all-time high. And mid-caps are trading at around 21% above historic levels versus large caps.
There’s plenty of cash in the coffers of many large-cap companies, which tend to hold up better in turbulent times. As I noted in a recent article about the business cycle, the recovery is still under way. Based on history, and where I think we are in the cycle now, the best places to be invested would be technology, energy, industrials and basic materials.
I’d stick with cash-rich stocks with better-than-average growth prospects. In technology, while Microsoft (MSFT) looks dirt cheap and has a ton of cash ($35 billion), I don’t see where the organic growth comes from. I’d opt for Apple (AAPL), which has $30 billion in cash and should continue to gain from iPad and MacBook sales. Plus, at 11 times forward earnings, the stock is cheap. TheStreet Ratings’ model has a $455 target on Apple, representing the potential for 40% upside from today’s levels.
In industrials, take a look at Fluor (FLR), the largest publicly traded U.S. engineering and construction company. Fluor has $13 in cash per share and is generating nearly $400 million in cash per quarter. In the first quarter, Fluor signed on $6.2 billion in new contracts, driven by demand for mining and infrastructure projects, mostly overseas. The stock has several potential catalysts for new business, including oil and gas projects in the Middle East, Russia and Canada. TheStreet Ratings’ model has an $87 target on shares of Fluor, representing the potential for 42% upside from today’s levels.
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