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Everything -- the global big caps of the Dow Jones Industrial Average ($INDU), oil and gold stocks, Chinese and Indian stocks -- seems expensive right now.
There aren't any obvious bargains in a world where stock markets from Mumbai, India, to New York are trading at historic highs. Forget about a sectorwide approach, either, because the few sectors that are trading at depressed prices -- home builders and financials -- are too toxic to touch. And adding to the problem is that the screening tools bargain hunters usually use -- price-to-book value, for example -- are wildly misleading right now.
What's a bargain hunter to do, especially now that the Federal Reserve is heavily hinting that Halloween's cut in interest rates might be the last for 2007?
Dig deeper, I say. The stock market is always misvaluing something. Right now that something is growth that's more than six to 12 months away. Current sky-high valuations make the majority of investors with money in the market nervous. Not nervous enough to sell but nervous enough to have an exit strategy and timetable in mind.
Almost nobody wants to bet on earnings growth much further out than the November 2008 elections, just before the Federal Reserve starts to raise interest rates again to support the dollar and quash resurgent inflation. That creates some intriguing bargains for investors willing to look that far ahead and with the patience and fortitude to ride out any rough patches between now and then.
In this column, I'll give you three bargain stocks for the far of sight and strong of stomach.
Cheap and cheaper
Most bargain hunters begin with a screen on one of the traditional value measures such as price to book or price to sales. Those parameters aren't doing a very good job of finding value these days because so many stocks that are cheap are in the process of getting even cheaper.If you run a screen looking for a price-to-book-value ratio below 1 -- which means you can buy $1 of book value for less than $1 spent in the stock market -- you wind up with a collection heavy on home builders and the banks and mortgage companies that financed them. (Book value is the value at which an asset is carried on a company's books. A home builder that owned land, for example, would put that asset on its books at the purchase price.)
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You can buy the book value of home builder Pulte Homes (PHM, news, msgs) for 75 cents on the dollar. For home builders Lennar (LEN, news, msgs) and Centex (CTX, news, msgs), the price is 77 cents on the dollar.
Financial companies that have been sucked into the mortgage crisis go for even less: Northern Rock (NHRKF, news, msgs), for example, for just 28 cents on the dollar, IndyMac Bancorp (IMB, news, msgs) for 55 cents on the dollar and Countrywide Financial (CFC, news, msgs) for 64 cents on the dollar.
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Finding the market lowIs the mortgage market at bottom? Watch the ratings companies. Until they downgrade some of the AAA-rated mortgage debt, forcing investors to sell, there still won't be a clear price -- and the mortgage market will still have farther to fall, says MSN Money's Jim Jubak.
Companies that provide mortgage and other kinds of financial-asset insurance are cheap, too, with MGIC Investment (MTG, news, msgs) selling for 40 cents per $1 of book value and MBIA (MBI, news, msgs) selling for 91 cents per $1.
The big money-center and investment banks that packaged mortgages for resale --and got stuck holding some of those mortgages -- aren't nearly as cheap, even now. Citigroup (C, news, msgs) shows a price-to-book-value ratio of 1.67, for example. Bear Stearns (BSC, news, msgs) comes closest to making the bargain cut at a price-to-book-value ratio of 1.05.
Why the ratio is misleading
The trouble is, book value doesn't tell an investor much when companies are busy writing down the value of the assets they hold on their books. For example, for the third quarter, Pulte wrote down the value of the land it holds by $1.2 billion. That's more than 10% of the company's book value. Mortgage lender Countrywide wrote down the value of mortgages and recorded losses on the sale of mortgages and mortgage-related assets by $1 billion in the third quarter. That's about 4% of the company's book value. Any investor thinking these stocks are bargains now because the price-to-book-value ratio is so low is betting that the write-downs are over. It's likely, though, that we're a long way from the end of the write-downs.Continued: Why price-to-sales ratios are misleading
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