Friday, September 16, 2011

Reasons to buy stocks now------By Shan Saeed

I was in New York last month and talking to Robert Kapito --President Black Rock Assets and asked his winning strategy in the current economic turmoil. He said, 60% in stocks, 20% in short term corporate bonds and 20% in commodities. Is this the way forward? Investors have to decide now about their risk-reward strategy in this volatile macro-environment. I see lot of blood for the next 2-years in the global financial markets. The noise in the market would continue for a very long period of time with dangerous headwinds.

I have made few distinctions between solid, growing companies and the flailing U.S. economy when I suggested to my readers few months back. “Buy Stocks, Not Economic Data.” I have clearly made the key difference between the two U.S. economies. One, “dead in the water” and the other appears to be recovering.

Market volatility is likely to stay around for awhile, so I advocate investors to adapt rather than head to cash. In my experience, it’s more productive to seek companies with aspects that will increase the probability of success. Research today gives us at least six:

1. Many companies are growing their revenues. According to my research, there are more companies with superior growth and value metrics today than there were in 2008. Among stocks held in the S&P 1500 Index today, nearly half have more than 10 % revenue growth. Of these revenue-generating businesses, I have found that the companies with the lowest price-to-earnings ratios have historically provided superior returns compared to the overall S&P 1500.

2. Businesses have seen higher profits since the bottom of 2009. Although nominal GDP has increased by only 8 percent, profits have increased by 65 percent due to expanding margins. During two previous timeframes when nominal GDP was low—1992-1997 and 2001-2006—profits rose faster. During the remainder of 2011 and 2012, there would continue to expand around 2 percent each year. These increased profits should benefit shareholders.

3. Dividend yields are attractive compared to Treasuries. Dividend-paying equities look particularly attractive relative to bonds, especially today. Over the last 40 years, the difference between the 10-Year Treasury yield and the S&P 500 dividend yield was usually more than 2 percent. During the early 1980s, the disparity reached a high of more than 10 percent, but rarely has the yield on the S&P 500 exceeded the yield on the 10-year Treasury bond.

It is generally recognized that the attractive dividend yield in comparison to a government bond, asking its readers: “Why…settle for returns of about 2 percent on U.S. government securities when world-beating U.S. corporations pay two to three times as much in dividend income?”

Instead of following the bears who are hoarding CDs and other low-yielding investments, investors have the opportunity to earn a higher yield and capital appreciation. Even if the market irrationally discounts the stock in the near term, shareholders continue to benefit by receiving a payment on a regular basis.

4. Global equities are undervalued. On a price-to-book ratio, global equities are currently at 1.5 times, which is a number well below the 30-year average of 2.2 times. This means shareholders are able to purchase many companies at only 1.5 times their book values.

5. Corporate executives are buying their companies' stock. Executives are acknowledging this attractive valuation because they have been buying their own companies’ stock shares. The historical average has been the reverse: for every buyer, two were selling. “Aggressive insider buying suggests officers and directors believe either their stock is too cheap or their near term earnings per share (EPS) outlook is better than the market believes. Further, insiders are a good predictor of where the stock is heading. Over 2010, during extreme points of buying or selling from executives, the stock price soon rose or fell.

6. U.S. money supply is rising. Historically, money supply spikes during a crisis or uncertainty in the market, such as Y2K, 9/11, the collapse of Lehman Brothers and ensuing financial crisis. It has been noticed that the money supply was rising and it would surely create inflation going forward. .

From Sept 2008 to Dec-2010, money supply in USA increased from $850 billion to $2.03 trillion, an increase of 138.6% in record 28 months. Fed Chief Ben Bernanke has lost all ammo to stimulate the economy.

Money supply is a key lubricant of the economy and financial markets, influenced by the Fed in an attempt to stimulate growth. Historically, if money is growing faster than nominal GDP, the excess money has found its way to other uses such as investment in stocks, commodities and other financial assets. We expect this trend to continue.

The risk/reward profile for owning stocks appears positively skewed. While bond investors have enjoyed a 30-year bull market, equity investors can now use long-term mean reversion to their advantage by buying those undervalued companies that are flush with cash, reward their shareholders with a dividend payment and have balance sheets that are the envy of government.

Disclaimer: This is just a research piece and not an investment advice. All financial transactions carry a RISK.

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