The main story in the financial markets for the second quarter has been the historic bull push in the S&P 500. Prices have seen a steady run higher in recent weeks, with no real examples of corrective pullbacks to the downside. Investors looking to buy-in at bargain prices are likely to feel as though the “train has left the station,” and that it is impossible at this stage to establish new positions at these elevated levels. But there are still reasons to be bullish on the S&P, and evidence to suggest that we are still well below an appropriate top in the central benchmark stock index.
Comparisons with the Dot-Com Rally
The best arguments for why the S&P is still undervalued can be seen when we look at similar rallies in the past. The most recent example is the dot-com rally seen in the late 1990s, where returns in the S&P 500 were above 26%. Since 2009, gains in the S&P have surpassed these levels and continue to press on to new record highs. But, while the pace of gains shows similarities, there are some critical differences in the underlying metrics used to determine appropriate values of these stocks.
Specifically, this means that market valuations should be compared to annual profits. During the 1990s tech boom, the collection of stocks in the S&P traded at a combined multiple of 25.7 times annual profits, with market momentum propelled largely by internet companies. Conversely, the gains made since the 2008 financial collapse (marked by notable bankruptcies, such as the one at Lehman Brothers), have come with underlying valuations of roughly 19 times annual profits. This is a difference of more than 25%, and a critical indication that stock prices are not all that expensive, even though some of the most closely watch indices are trading at record highs.
Solid, stable gains
To be sure, the 2008 financial collapse created one of the worst economic meltdowns since the 1930s. But when we look at the corporate performances that followed, the current rally starts to look more stable and well-positioned for further gains. Yearly profit growth in American companies has improved strongly, at a rate of 20% since the 2008 financial collapse. This doubles the profit growth rates these companies were able to generate in the late 1990s. In 2000, companies in the S&P 500 earned $431 billion. In 2012, that number rose to $785 billion (an increase of 82%).
These trends offer consistent evidence of improved performance and support argument that stocks are not actually overvalued, despite trading an new record highs. These are encouraging factors for investors still long these markets, as there is strong support for the current bullish sentiment.
Stocks to watch
Looking at specific names, supermarket powerhouse ConAgra Foods, Inc. (NYSE:CAG) is a standout choice. Recent acquisitions include this year’s $5 billion purchase of Ralcorp, which should be key in exposing ConAgra to previously neglected areas of its market.
Credit: ConAgra Foods, Inc. (NYSE:CAG)
Another option is Molson Coors Brewing Company (NYSE:TAP), which trades at only 1.2 times its book value. This compares favorably to other companies in the sector, with common examples seen in Anheuser-Busch, which trades at 3.9 times book value or Boston Beer, which makes Samuel Adams and trades at a massive 8.7 times book value. Additional positives for Molson Coors Brewing Company (NYSE:TAP) can be seen in its reported cash flow, which has grown for three straight years.
