Investing in today's record-setting stock market is much like shopping at an exclusive retail store. Bargains are few and far between. There's a pricey smell about the place.
"Stocks are very expensive, whether the measure being used is earnings, book value or dividends," observed E. Michael Metz, analyst with Oppenheimer & Co. and a tracker of deep discount stocks. "When you must look to earnings six months down the road in order to justify a stock price, you're definitely entering dangerous territory."
The greatest danger, of course, is that of a stock market correction. It would wreak havoc on all those fancy price tags.
Keeping in mind the basic investor goal to "buy low, sell high," many technical factors do indicate caution. Prices are based on projections about the future, and the hopes and dreams that these include aren't always firmly based in reality.
"It's getting harder and harder to find undervalued stocks, since investors seem convinced that earnings will catch up to stock prices," said Arnie Kaufman, editor of the Standard & Poor's Outlook. "When corporate earnings are depressed as they have been during recession, it's hard to accurately evaluate the value of stocks."
It may be time to forget about the designer labels and head straight for the bargain rack. Oppenheimer, for example, puts together a quarterly list of deep discount equities. To qualify, a stock must sell at half the valuation of the average stock in the market.
It emphasizes the price-to-earnings ratio (P/E), the price of a stock divided by its earnings per share, which indicates how much is being paid for a company's earnings power. Oppenheimer's screen also considers book value, which is the net asset value of a company. That not only helps find underpriced stocks, but indicates the ultimate value of securities in liquidation.
The maximum allowable P/E on the Oppenheimer list is currently 12.5 times earnings, which compares to the much more expensive 25 times earnings at which the S&P Industrials are currently appraised. The average P/E of stocks on the Oppenheimer deep discount list is a stingy 9.5 times earnings.
"There's a reason why some stocks are cheap, in that they may have real financial problems that won't be solved," explained Metz, who believes the market's current prices are a cautionary flag telling investors to invest only when they can find low-price entry.
Metz is optimistic about financial stocks such as banks, savings and loans and insurance companies because their price is right. The image of 1980s debt woes makes investors cautious. His favorite financial stocks are Chase Manhattan, Countrywide Mortgage, National City Corp, NBD Bancorp, St. Paul Cos., American General and Banco Bilbao Vizcaya.
Inexpensive stocks in other groups include Lockheed Corp. in aircraft, missiles and space and Shell Transport & Trade.
Among stocks currently depressed in price and likely to outperform the overall market over the next six to 12 months, Kaufman likes Hanson PLC, which has been hurt by the poor British economy and isn't earning much on its huge cash position due to prevailing low interest rates; Westinghouse Electric, which despite recent disappointments should benefit from the economic recovery; and International Business Machines, whose earnings and prospects are both getting brighter.
Other undervalued picks include Sears, Roebuck, which Kaufman believes is finally "getting it all together"; BankAmerica Corp., whose merger with Security Pacific will be of financial benefit; and GATX Corp., which has a solid if glamorless business in rail car leasing.
Additional favorites are Pittston Co., an "ugly duckling" with good dividends and solid prospects and Commodore International, whose recent disappointing earnings don't take away the popularity of its computers in England.