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.
In addition to its comparative value advantages, Molson Coors also announced a quarterly dividend of $0.32 per share. First quarter earnings were much stronger than expected, and have propelled the stock to a new 52-week high with a year-to-date gain of nearly 9%. The company’s strong first-quarter sales, which beat analyst estimates by nearly 20% came largely as a result of added StarBev operations. Molson Coors Brewing Company (NYSE:TAP) has a long-term estimated EPS growth rate of 5.40%, creating an attractive opportunity for those still looking to be long in stocks.
Look for dips as new buying opportunities
Common market maxims suggest that investors should be looking for opportunities to “buy low and sell high.” With stocks trading at elevated levels, these practices become more complicated. Those with a bearish stance might argue that weakness in benchmark P/E ratios suggests a general lack of confidence for a sustainable economic recovery. In addition to this, the case can be made that the tech rally in the 1990s ultimately resulted in a market bubble that created $5 trillion in losses once the major downside corrections were seen.
But when we look closer at valuations based on profit performance, steady improvements become apparent and stock prices start to look more attractive on long term time horizons. Comparisons to rallies in recent years suggest that a more sustainable bullish scenario is in place. This means that downside corrections are likely to be limited and should be viewed as new opportunities to establish buy positions. Even with price levels in the S&P moving into the mid-1600s, share values are still relatively cheap in the broader picture.
The article Reasons to Stay Bullish on the S&P 500 originally appeared on Fool.com and is written by Richard Cox.
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