It's official: stocks are cheap. Analysts estimate that the S&P 500 companies will earn $96.34 per share as a group in 2010. Based on those projections the S&P is trading just under 11 times forward earnings.
And dating back to 1960, whenever the forward P/E has dipped between 10 and 15, the historical 12-month return is 12%, according to Oppenheimer Asset Management. Not too shabby. In fact, the forward P/E ratio of the S&P 500 hasn't been this low in 15 years.
But just because stocks are inexpensive now doesn't mean they can't still get cheaper. Take the 1970s and 1980s, for example, when the S&P's P/E ratio spent a good chunk of the time in the single digits. Of course, times were tough back then. But we're not exactly flush right now either. However, when stocks do approach these valuations, it's a good idea to start sniffing around to see if there are any bargains to be had.
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Look skyward for signs of an economic recovery
I don't try to time the market. Instead, I look for great companies that are growing earnings and have other advantages.
So with many stocks currently trading at multi-year low valuations, let's see if we can find a few that are not only cheap, but also have outstanding future prospects.
Atlas Worldwide (Nasdaq: AAWW): Right off the bat, let's start with a company that you can invest in as a way of playing the economic recovery.
Atlas is an airline cargo firm whose business was hit hard, due to the recession. No surprise there.
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But things are picking up now. First-quarter revenue jumped by 25% over Q1 2009 and its earnings per share is rising, too. The company is expected to earn $4.23 per share in 2010, giving it a forward P/E of 11. And over the next five years, earnings are projected to grow 12% annually.
Additionally, the business generates a lot of cash. Despite a difficult 2009, Atlas managed to bring in $184 million in free cash flow. That equates to a price-to-cash flow ratio of under 7. And if you read my column a couple of weeks ago, you'll know that price-to-cash flow is another important valuation metric that I use.
As business conditions improve, more cargo will need to be shipped - a trend that should be reflected in Atlas' bottom line and share price.
Let's dig around in the bargain bin for two more cheap stocks.
Healthy, wealthy and wireless
Cigna Corp. (NYSE: CI): Healthcare insurance firm Cigna is focused on large employers that generally self-insure. Cigna handles the administrative duties, which makes the company less susceptible to increasing healthcare costs.
Cigna's forward P/E is just 7.2 and its price earnings-to-growth ratio (PEG) is 0.75, compared to the industry average of 0.98. Its earnings are projected to grow by 10% per year over the next five years.
With healthcare reform signed, the changes implemented will prove valuable for health insurers' businesses, as 30 million new customers will be insured.
MetroPCS (NYSE: PCS): The wireless services provider is enjoying success with its "Wireless For All," pay one price plan. During the first quarter, revenue jumped 22% on the back of a 21% jump in subscribers.
Analysts project that earnings will grow by a whopping 24% per year over the next five years. And you can be part of that torrid growth for just 11.5 times forward earnings.
The stock is inexpensive by other metrics, too. For example, its price-to-sales ratio is just 0.8, while it's also trading for a mere 3.6 times cash flow.
The Buffett philosophy
When you're analysing stocks, valuation shouldn't be the only measure you use. But if you like the idea that Warren Buffett advocates - buying good, quality companies on the cheap - looking for those that have low forward P/E ratios is a good place to start.
Just be sure that the company's earnings are expected to grow at a solid pace. The last thing you want to do is buy a stock that's cheap for a good reason.
This article was written by Marc Lichtenfeld for the free daily investment email Investment U
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