James Altucher argued this week on Realmoney.com that "The Market is Dirt Cheap":
Let’s just say it: Right now the stock market is baking in a depression.
This means that people are not just assuming a slowdown in sales — they are assuming a complete reversal in sales, perhaps even 10%-20% declines in the sales at these companies, which are some of the largest components of the S&P 500.
I couldn’t agree more. Based on a Baseline measurement which calculates the premium or discount of a company’s earnings vs the 90 day treasury, the S&P 500 is trading two standard deviations below its historical price premium. In fact, it’s basically trading at the "baseline" or the risk free rate. If the S&P simply returns to its median historical valuation vs the risk free rate, it would be trading around 1750, as the following chart shows…
Altucher points out several large cap stocks are now trading at 10 year lows based on price to book, price to earnings and price to sales ratios…
For instance, GE has a price/book ratio of 3.2. The company has increased its book value every year for the past 10 years. Its average price/book for each year in the past 10 years is (starting with 2004 and going back): 3.5, 3.9, 3.8, 7.2, 9.4, 11.9, 8.5, 6.7, 5.2 and 4, respectively.
In other words, the market is valuing GE at a lower level than it has at any time in the past 10 years. Again, the market is giving zero credit for continuing any growth and the market is baking in a huge slowdown in sales and growth. Yeah, GE’s price is higher than it’s been at the lows, but its cash flows and book value have improved over the past several years as well. The stock price has not reflected that improvement at all, as evidenced by these ratios.
Then there’s Intel, which has a P/S of 3.8 and a P/Book of 3.8. Both ratios are near the lowest levels of the past 10 years (except for a brief time in 2001 when it was lower in the middle of the last recession) despite the company steadily increasing its book value each year (except for a small decrease in 2000). I like to see an increasing book value just like I like to see my checking and savings accounts grow each year. It shows that not only are you making more money, but you are saving it or building value with it as well. A steadily increasing book value gives me some comfort that the company has experienced little volatility in its growth.
I would expand the argument and say you can basically throw a dart at the S&P 500 and have a good chance of hitting a high quality stock trading at least one standard deviation below its historical price premium. The following list includes over 160 stocks that have an S&P 500 rating of B or better (a measure of quality based on earnings stability and dividend sustainability), should grow earnings above the avg S&P 500 earnings growth rate of 7%, and are trading at least 1.5 standard deviations below their historical median valuation.
Some of these companies have good reason to be trading at historical low valuations but many are simply out of favor as investors flee to oil and gold stocks. Companies such as Walmart and General Electric have been putting up good numbers and are simply way out of favor because the ugly macro economic environment.