Cheap stocks take the lead going into 2014

Is anything not overvalued at this point? Investors are trying to find value in shares seen as bargains, which could keep the rally going next year.

By MSN Money Partner Dec 31, 2013 3:24PM
Dice on newspaper stock pages © Tom Grill, PhotographerBy Alexandra Scaggs, The Wall Street Journal

Investors are homing in on shares seen as bargains, a shift that bulls say could keep this year's epic stock rally going in 2014.


Leading the Standard & Poor's 500 Index ($INX) this year are stocks with characteristics that broadly place them in the "inexpensive" category: those with relatively low valuations based on earnings forecasts and increasing estimated profits, among others. The performance comparisons were based on data compiled by mutual-fund giant Fidelity Investments.


Some money managers say the bigger-than-average gains in these shares are a sign of the market's health. In recent years, investors scrambled for stocks that paid big dividends, often paying little heed to valuations, as they searched for yield at a time of record-low interest rates.


Now, interest rates are rising after the Federal Reserve earlier this month said it would begin dialing back stimulus measures, and investors are changing tack. Many investors took the Fed's move to be a vote of confidence in the economy and an impetus to stay in the stock market.


This year's relatively strong performance of bargain-bin stocks shows that investors are taking more risks but also remain cautious about how they are loading up their portfolios. The 100 stocks in the S&P 500 with the lowest price/earnings ratios rose 41%, on average, in the first 11 months of the year, compared with a 27% gain in the S&P 500, according to Fidelity.


"It's not a high-growth, really-get-excited environment," said Christopher Bartel, senior vice president of global equity research with Fidelity, which manages some $1.9 trillion of investor cash. "That, in a lot of ways, is positive. It's not too hot, it's not too cold."


Well-publicized rallies in the shares of companies such as social-media network Twitter (TWTR) and electric-car maker Tesla Motors (TSLA) have prompted market experts, analysts and observers to ask if the stock market is overheating. The Dow Jones Industrial Average has set 50 closing record highs this year on its way to a 26% gain, on track for its largest annual rise since 1996.


But companies such as Delta Air Lines (DAL) are more representative of what is driving the current rally, a fact that gives some investors reasons to stay optimistic. This year, Delta has consistently had among the lowest P/E ratios in the S&P 500, but has jumped 128%. Delta trades at 10.3 times estimated earnings for the next 12 months, according to FactSet. The average P/E ratio for the S&P 500 is 15.4.


While the U.S. economic recovery has looked sturdier in recent months, growth in corporate profits is slowing. Because of that slowing growth, investors are becoming wary of overpaying for individual stocks. The 10-year average for the S&P 500's P/E ratio is 14.1, according to FactSet.


"Stocks aren't as cheap as they were, so it's important to look for those that have more attractive valuations," said Kate Warne, investment strategist with Edward Jones, a financial advisory firm.


The rise in bond yields this year has limited the appeal of higher-yielding stocks such as utilities and real-estate investment trusts. On Friday, the yield on the 10-year U.S. Treasury note rose above 3% for the first time in more than two years.


Interest rates still remain low compared with historical levels, however. And since the U.S. economy has been steadily improving, investors took on more risk in 2013, said Jeff Knight, head of asset allocation at Columbia Management, which manages $327 billion.


"I don't want to own the bond-like stocks anymore, but I don't want to overpay," he said.

Because stock buyers didn't want to pay too much for shares, the move into riskier assets was a small one, he said, leaving more room for the trend to continue.


Mr. Knight said his firm has been adding to holdings in some technology stocks, which are trading at low valuations relative to historical levels. The tech sector of the S&P 500 is the only one trading at a valuation below its 10-year average, according to FactSet. It is trading at 15.5 times expected earnings for the next 12 months, below its 10-year average valuation of 16.7.


After companies with relatively low P/E ratios, those with increasing earnings estimates were the best performers, according to the Fidelity data.


Biogen Idec (BIIB), for example, has seen analysts raise their 2014 earnings projections to $11.44 per share from $8.89 per share this year, according to FactSet. Its shares are up 89% this year.


Andrew Slimmon, managing director with Morgan Stanley Global Investment Solutions, part of the bank's wealth-management branch managing $2.4 billion for clients, said he will continue to target stocks with low P/E ratios in early 2014, because many stocks still are trading below their long-term average valuations. He said he is looking for shares with low valuations, rising earnings estimates and rising prices.


"If you think back to the late 90's, after a decade-long bull market, you couldn't find companies with that combination," he said. "If you have good earnings revisions and good stock-price performance, they certainly didn't have low P/E [ratios]."


He has been buying technology giant Apple (AAPL), he said. Apple is trading at 12.6 times its projected earnings for the next 12 months, well below its 10-year average of 23.6. It also has seen rising earnings estimates, and strong stock-price performance in recent months.


To be sure, as stock benchmarks grind higher, inexpensive stocks will likely be tougher to find, strategists say. The cheapest 100 stocks in the S&P 500 were trading at 11 times their expected earnings for the next year as of Nov. 30, above their 20-year average valuation of 9.3, according to Fidelity.


While most investors search for bargains, others are buying shares that have shown strong returns over the past year, a strategy known as momentum trading. Shares of Tesla Motors, a favorite pick of momentum traders, are up 346% this year, for example.


Momentum stocks in the S&P 500 such as Netflix (NFLX) and Best Buy (BBY) were the fifth-best performing group this year, according to Fidelity. The group notched gains five percentage points above the S&P 500's rise as of the end of November.


"Some tech names that have had tremendous returns could still pick up" if the rise in investor optimism continues, said Paul Zemsky, chief investment officer of multiasset strategies at ING U.S. Investment Management, which manages $180 billion.


More from The Wall Street Journal

29Comments
Jan 2, 2014 8:46AM
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If we step back and observe, there is no aspect of our current structure geared to actually support an economy, it supports takers. The Federal Reserve and US Treasury work to create debt, the banks and Wall Street support markets. The markets support non-enterprise business platforms that support degrees administrative and executive personnel, none of whom actually "do" anything (paper & button pressing are not jobs, they are functions), at best they just delegate. They support deadbeats, lawyers, accountants, politicians, administrators and psychopaths.

The encouraging part is-- we are beginning to define the problem and the problem people. It will be a much easier task once they are the only ones in this stupid loop and the remaining majority can wipe them off the face of the Earth.

Terrorists deserve nothing better.

Jan 2, 2014 11:23AM
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"A former banker accused of faking his own death in 2012 to cover up the theft of millions of dollars has been arrested after a traffic stop in Georgia, authorities said. Aubrey Lee Price, 47, was arrested on Tuesday after Glynn County sheriff’s deputies stopped him on Interstate 95 in Brunswick, Ga.,  and discovered his identity, . Heavily tinted windows in a 2006 Dodge Ram pickup truck were his downfall. Price was wanted in connection with an investment scheme in New York in which he is alleged to have stolen millions between January 2011 and January 2012,  He was accused of moving $21 million into accounts to hide his thefts and losses from investments and trading when he was a director of a southern Georgia bank. He was last seen in Key West, Fla."


I pasted this here so readers could see who is handling their money. 

Jan 2, 2014 2:43AM
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Don't know how many of you remember the internet bubble back in 2000, but the social media stocks' run-up reminds me of that. Come this spring I will likely be shorting the hell out of TWTR and FB. Give them a year or so to fall into the single digits.
Jan 2, 2014 8:36AM
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Is anything not over-valued at this point?" AND YET... day after day the Kool Aid crowd attempts to justify a market without an economy that will just keep going and going and going and going to Hell without hand baskets.
Jan 1, 2014 2:03PM
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Bang, bang, bang....Got a bigger barrel. arf, arf, arf.
Jan 1, 2014 2:16PM
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Har har har and a Meow, meow, meow....

Looks like at least a dozen of us were
not invited to any NYeve parties and
were safely tucked in by 9 PM, eh?

OH, sorry CAT...we have to interlace
this with something about economics.

Hmmm, okay!  The market is clearly
not overvalued by most metrics, especially
'investor exuberance', but that does not
mean 'caution' should not be a keyword
by now. 

Over and Me-owt !!

Jan 1, 2014 9:57PM
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Some stocks are cheap for a reason,there`s no potential.
Jan 1, 2014 2:37PM
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Yup quiet 2014....Didn't think any house parties down at Lake ??

Friends stopped by, he had been in town at couple of clubs, one with DJ or something, other was quiet too.

We had a Half bottle of Reserve..

Miss Lilly not much...

Fell asleep about quarter of 12....Miss Lilly woke me up at the hour..

Neighbors fired off some fireworks or their cannon....

Went back to sleep.

Happy 2014....Left my picks and advice on Caterpillar article...

Only road I worry about is one to Casino and Grocery store...

Walk down driveway to mailbox to get money....HNY.

Jan 1, 2014 8:31PM
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"The average P/E ratio for the S&P 500 is 15.4."

"The 10-year average for the S&P 500's P/E ratio is 14.1, according to FactSet."


"is" as if the projected P/E at the end of 2014 -which is what's being described- has already occurred.


This puts one more layer of inaccuracy in judging stocks.  Why not look at stocks with low P/E's NOW, with information that's factual.  Then connect it with stocks that have steady' long-term growth in earnings so that you have a high probability of knowing where the stock will be in the next few years.


Some of the Healthcare REITs that have superb steady long-term growth in funds from operations (FFO, the REIT equivalent of cash flow), and are paying 5%+ dividends that are less than 3/4 of FFO.  One, HCP, has a Price/FFO of 14, is paying a 5.8% dividend that represents a 72% payoff of FFO, has raised dividends 28 straight years, and has dropped significantly in stock price because investors are identifying REITs with bonds -even REITs with a lot of short-term contracts like Healthcare REITS, and are spooked because the board of directors unexpectedly fired the CEO in 2013.


Many of the oils look good with low P/E's like Exxon and Conoco Phillips.


Things look gloomy for electric and gas utilities because of recent warm winters and more efficient electronics which have reduced American electric consumption to 2002's level as well as rising interest rates on debts.  Electricity use is expected to drop another 1% in 2014. But do you think government regulatory boards are going to deny utilities the rate increases they'll need to keep functioning, including repairing lines in bad weather?  Now is the time to buy utilities.  One of the few growing earnings despite a major renovation and expansion is Southern Company, which pays a 4.94% dividend, is building the first new nuclear plants in a generation near Augusta, Ga. Southern is also involved in the development of a state-of-the-art coal gasification plant that will go online in Q4, 2014 and it also operates one the largest photovoltaic and biomass plants in the U.S.

The gasification plant is a 582-megawatt electric power plant that features a high-efficiency technology capable of utilizing lignite, which accounts for more than half of the world's coal reserves. This technology converts lignite to gas at a much lower temperature than traditional coal conversion, resulting in significantly lower costs than what's possible with existing gasification technologies. The simpler, more efficient technology used by the Kemper facility will allow for more power production at a lower capital cost, as well as lower operating and maintenance costs. It's also more environmentally friendly.


Jan 1, 2014 9:18PM
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I may just look into the Health Care REITs...

I'm about done with NLY and AGNC...

Possible roll out and back in somewhere else..

We have done well on your other type suggestions.

Some don't like Tobacco, but it has been stellar.

I try not to mix morality, with investment ideas.

HNY...

Jan 1, 2014 7:07AM
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2013 was like shooting Fish in a Barrel. I suspect 2014 will be just the opposite.
Dec 31, 2013 11:13PM
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Is anything not over-valued at this point?" AND YET... day after day the Kool Aid crowd attempts to justify a market without an economy that will just keep going and going and going and going to Hell without hand baskets.
Dec 31, 2013 6:53PM
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"Is anything not overvalued at this point?"  Nope.  Only question is by how much they are overvalued. 
Jan 1, 2014 10:44AM
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Fraud Street starts the year off....... CLOSED! Now if we could only keep it closed the other 364 days of the year, America would heal from all it's wounds it has suffered from this atrocious PONZI SCHEME. The rich taking from everyone else. How sinfully delightful!

Stocks are not needed to be successful in life! Stocks are not needed to be wealthy in life! Stocks are not need to be healthy in life! Stocks are not needed to be happy in life! Stocks are not ever needed anywhere in the world!

DIE FRAUD STREET, FOREVER DIE!

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