What Side Are You On?
I can understand when investors are bearish on the stock market and the U.S. economy. After all, there are always two sides to the coin, forget about all the ridges along the outer perimeter. Official unemployment is near 10%. The housing market is only gradually improving, and there's record government debt here in the U.S. and in many other countries.
But the bears need to take another look before they add high stock valuations to the laundry list of downside catalysts. Because the numbers say stocks are as cheap as they've been since 1990. I think the market needs to pull back a bit in order to hold onto the gains it has made in 2010 - but ultimately I believe many stocks should be trading higher than they currently are.
Sure, it's easy to look at the 80% move by the S&P 500 and think stocks must be expensive. Same goes for the Russell 2000 which has moved over 100% higher since the March 2009 lows.
But so far, 1st Quarter earnings have beaten analysts estimates by an average of 22% (according to Bloomberg) and 80% of reporting companies have beaten expectations.
Analysts have raised forward earnings estimates for S&P 500 companies by 9.3% in April. The index has responded with a 3% move in April.
Analysts say that S&P 500 companies will earn $85.96 a share in 2011. The record for per share earnings is $89.93, set in 2007. The S&P 500 was 20% higher then. The current P/E for the S&P 500 is 14.
What is really interesting is that I’m seeing a lot of analysts raising earnings estimates, but not increasing their ratings on stocks. This is especially true for small cap stocks. Bloomberg points out that only 30% of U.S. stocks have a "buy" rating. It seems rational to assume the rest are "holds" or "sells."
When analysts change their rating on a stock, it's usually headline news. But when estimates change, there's usually not much fanfare. In fact, you might not even know unless you go to a website like Yahoo! Finance and look for yourself at the latest analyst earnings expectations.
I expect this is why some investors are still skeptical of the stock market’s rally - and are hesitant to put new capital to work at these levels.
***The reality is that corporate earnings will grow until they don't. And once analysts start estimating flat growth (or horror of all horrors, decreasing growth) there is usually a nasty correction.
But there are usually signs when this starts to happen. But so far, no analysts are coming out and questioning whether earnings estimates are too high. In fact, it's pretty clear that corporate earning power continues to surprise analysts. And they continue to play catch up.
It's unlikely that earnings will all of a sudden reverse course anyway. We should at least see a quarter or two where earnings are pretty much in line with expectations. Until that happens, a bullish bias towards stocks is appropriate.
***This weekend marks one of the biggest investor events of the year – Warren Buffet’s annual shareholder meeting for Berkshire Hathaway (NYSE: BRK-A). There could be as many as 50,000 people in Omaha, Nebraska looking to glean investment advice from Buffet and Vice Chairman Charlie Munger.
I recently put together a special report that includes three stocks that Buffet would love to buy. These companies have strong corporate culture, great leadership, and good cash flow. And one of them has a market cap of only $780 million.
Buffett can’t invest in this stock because it’s too small. But you can, and I’d like to give you the opportunity to find out more about it. Between today and May 1, I’m giving subscribers to Small Cap Investor Daily an opportunity to get my Special Report: The Warren Buffett Retirement Planfor free when they sign up for a subscription to Top Stock Insights. This advisory service covers stocks across the full spectrum of market caps - and there is one small cap in particular that I think you’ll find compelling.
Savvy investors already know that Warren Buffett is the greatest living investor. But it's tough to match his gains unless you buy stocks BEFORE he does.
