U.S. Stocks Remain Undervalued
John Butters, a research associate with Thomson Reuters, said the bottoms-up earnings-per-share estimate for the S&P 500 for 2011 is $95.77. Market observers note that a traditional 15-times multiple would mean the S&P 500 would reach 1436 by the end of 2011, an increase of 200 points, or nearly 16%.
The estimate for earnings of the S&P 500 companies is nowhere close to projecting increases, argues Pado, which means the market has a low hurdle to top. "As demand picks up, I think 1350 is a low-end target for next year," he says.
Robert Pavlik, chief market strategist with Banyan Partners in Palm Beach Gardens, Fla., says that at 13 times next year's estimates, the market is undervalued."Without even seeing any expansion in earnings, a 15 multiple is quite doable and maybe even conservative," he says. "At a 16 multiple, without any type of expansion in earnings, you're talking 1500 on the S&P 500. That's pretty reasonable." Two arguments counter that view. The first is that buy-and-hold is dead. During the so-called "lost decade," large cap stocks -- and therefore the major stock indices -- went nowhere. It's hard to believe that will change in 2011. Second, as the chart above shows, the actual performance of S&P 500 earnings lags expectations over the several quarters dating back to 2006. Cantor Fitzgerald's Pado, though, points out that U.S. corporations should see cash and cash equivalents held on balance sheets top $2 trillion by the end of this quarter, four times the average level. Companies hoarded this cash on double-dip recession fears, but now they will be forced to put it to use. "That's what has been lacking in the valuation of the market," Pado says. "There's no rate of return, and they're not building their companies up. That's when you get buybacks, M&A activity and increased dividends." Banyan Partners' Pavlik offers several stock picks across sectors held in client accounts at his firm. He finds value in the financial industry, and he views Bank of America (BAC) as a long-term investment. Citigroup (C), he says, should "easily see $7 over the next year or so." Among industrials, Pavlik looks to Boeing (BA) ahead of the delivery of the Dreamliner 787 plane. "They've had a lot of hiccups in the production, but once that plane begins flying, people are going to jump all over that stock," he says. Last, he said value can be found in the materials sector, noting that FMC Corp. (FMC) trades at 14.5 times next year's earnings estimate and Cliffs Natural Resources (CLF) only at 7.5 times next year's earnings. Large-cap dividend-paying stocks are Buckingham's top picks for 2011, based on a hunch. "I don't know. That's my honest response," Buckingham says. "But as a value manager and an equity investor, I want to be putting my money in inexpensively priced stocks. Ultimately, the value will get recognized. As Buffett says, if the business does well, the stock will follow." Buckingham's focus falls on technology, targeting Intel (INTC) and Microsoft (MSFT), even though the dividend yields are spectacular. "The P/E ratios for each are in the 12 range," he says. "These are fantastic balance sheets loaded with cash. Earnings are expected to grow modestly and the downside risk is relatively subdued."