U.S. Stocks Get Most 'Buy' Ratings in 3 Years

BOSTON (TheStreet) -- Stocks have been on a remarkable ascent since the "world is ending" bottom in March 2009. (The S&P 500 Index is up about 80%.)

Investors have become more optimistic and willing to assume higher risk. However, many are still waiting for signs of economic stability, what with elevated unemployment, the down-and-out housing market and woes in Europe and Japan. Today's news that Standard & Poor's put U.S. sovereign debt's AAA rating, the highest, on a "negative" outlook is hammering stocks, with the S&P 500 down almost 2%.

Since the financial meltdown and deep economic recession of the past three years, investors have been skittish about pouring money into stocks. Today's S&P release shows that every bit of negative news has the potential to derail the stock-market rally.

Digging deeper, though, reveals that U.S. equities are attractively valued. While a 10% drop in the market is certainly a possibility, if you're waiting for a double-dip or a retracement to early 2009 levels, odds are that you might be waiting for a long time.

TheStreet Ratings' quantitative model -- overseen by a unit of TheStreet -- currently rates 37% of our 6,000 stock universe a "buy," the highest since September 2007 (see graph below).

Keep in mind, the model focuses on both risk and reward, looking at not only the fundamentals of a particular stock (such as growth in revenue and cash flow) but also the overall financial strength and possibility of bankruptcy.

This leads to a favoritism toward stocks with solid growth, clean balance sheets, strong past relative performance and attractive valuations.

As shown in the graph, only 6.5% of companies had "buy" ratings in April 2009, mainly due to the credit issues that plagued every sector. While the signal wasn't perfect, the overall "buy" ratings started to move higher at an accelerated rate (compared with the S&P 500), as the model determined that the reward-to-risk for many companies was greatly improved.

Today, the S&P trades at just 13.5 times estimated 2011 earnings. Historically, the S&P 500 has traded at a forward price-to-earnings ratio of 15. As earnings and profit margins have recovered substantially since the recession, there are reasons to be optimistic. One is that interest rates remain at historic lows. Second, while the early earnings recovery was fueled by layoffs, restructuring and cost-cutting, growth is being fueled by higher business spending. Any improvement in earnings growth over the next several quarters, combined with increased optimism, could fuel a continued bull market.

Here's a look at the industries with the largest percentage increase in "buy"-rated stocks over the past six months.

As shown above, our model has become more bullish on several financial industries (thrifts and mortgage finance, and diversified financial services), mostly indicating an improvement in balance sheets, and an increased confidence (for our model) in the overall financial strength for several companies.

In particular, Northwest Bancshares ( NWBI) and MarketAxess Holdings ( MKTX) are two of our highest-rated financial companies.

In IT services, our model likes Automatic Data Processing ( ADP), Cognizant Technology ( CTSH) and International Business Machines ( IBM).

In food and staples retailing, the model has identified Price Smart ( PSMT) and Whole Foods Market ( WFMI) as the most attractive within the industry, mainly driven by an increase in consumer spending.

And, at the bottom of this page, are the 10 industries with the largest decline in "buy"-rated stocks over the past six months.

Within household products, the model has become more bearish on companies such as Clorox ( CLX) (dropped to "hold" from "buy" in September), based mainly on valuation and slowing profits. Owens Corning ( OC), within the building-products industry, was recently downgraded to "hold" from "buy." Owens Corning, which is up nearly 40% over the past six months, was downgraded by the model because the share price got ahead of earnings prospects.

In beverages, our model moved to "hold" from "buy" on Molson Coors ( TAP) due to slowing growth at the beer manufacturer. The company announced a quarterly drop in revenues of nearly 5%.

Equity research manager Chris Stuart, CFA, joined TheStreet Ratings after working as a senior investment analyst with Merrill Lynch covering small-cap equity and alternative investment strategies. Prior to that, Stuart worked for One Beacon Insurance as an actuarial analyst and at H&R Block as a financial adviser.

Stuart earned his bachelor�s degree in finance from the University of Massachusetts, Amherst. He holds a Chartered Financial Analyst (CFA) designation and is a member of the Boston Security Analysts Society (BSAS) and the CFA Institute.

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