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We have already looked at the Dow Jones 30 and examined the "cheapest" stocks based on a prices against 5-year earnings ratio -- the theory being to look at the long-term earning potential of these mammoth companies and see what turns up. We now expand this to include the S&P 500 (NYSEARCA:SPY) -- the biggest 500 companies in the US which will be pretty sizable concerns and likely to weather the current market storms.

Anand Chokkavelu from the Motley Fool picks up this thread and provides this analysis. He summarizes the target companies --500 of the biggest public companies in the U.S. stock market. It pretty much encompasses all the names you can think of -- Apple (NASDAQ:AAPL), Coca-Cola (NYSE:KO), [[IBM]], P&G (NYSE:PG), ExxonMobil (NYSE:XOM), Bank of America (NYSE:BAC), Verizon (NYSE:VZ), FedEx (NYSE:FDX), McDonald's (NYSE:MCD), Johnson & Johnson (NYSE:JNJ), Wal-Mart, and Amazon.com (NASDAQ:AMZN), to name a few. It captures around three-quarters of the value of the entire U.S. stock market and includes most of the leading companies with market caps above $1 billion. ExxonMobil leads the list at $375 billion

He then goes on to outline the 10 lowest five-year P/E ratios in the S&P 500.

Company Name

Industry

5-Year P/E Ratio

MEMC (NYSE: WFR) Semiconductors Including Solar 4.0
Hewlett-Packard (NYSE: HPQ) Tech 6.7
NRG Energy (NYSE: NRG) Utility 6.8
Assurant (NYSE: AIZ) Diversified Insurance 7.0
Travelers (NYSE: TRV) Property and Casualty Insurance 7.0
Western Digital (NYSE: WDC) Tech (Data Storage) 7.1
WellPoint (NYSE: WLP) Health Insurance 7.2
Corning (NYSE: GLW) Specialty Glass and Ceramics 7.4
L-3 Communications (NYSE: LLL) Defense 7.6
Diamond Offshore (NYSE: DO) Offshore Oil and Gas Drilling 8.0

Source: S&P Capital IQ. Excludes companies with significant discontinued operations and/or fiscal-year changes.

Anand provides some analysis for the beaten down prices.

  • MEMC's profitability on its silicon wafers has plummeted
  • HP and Western Digital face obsolescence and competition
  • NRG Energy's latest 12-month profitability is less than half of its five-year average
  • Assurant, Travelers, and WellPoint all face balance-sheet scrutiny in a post-AIG-blowup world, and Assurant and Wellpoint face the uncertainty of future health-insurance regulations.
  • Corning faces both potential lower demand for its specialty glass in the LCD TV market and margin compression.
  • L-3, like all U.S.-based defense contractors, lives at the mercy of future U.S. government defense budgets
  • Diamond Offshore is an offshore oil and gas driller. Post-BP's 2010 Gulf oil spill, the drillers have had regulatory concerns priced in.

So we have the classic bargain hunter's conundrum in front of us. We see very cheap prices but very real risks.

I think that this is a useful filter but as Anand goes on to point out, there is a degree of Caveat Emptor -- while the long-term nature of these stocks means that they will find a way to strengthen themselves, there is the risk of buying into a company in long-term demise.

However, looking into the bargain bin but only looking for the largest 500 companies in the US, mitigates risk somewhat. We also recall that these giant companies are likely to have global markets, which diversifies risk (for good and bad).

So, we will measure this selection of equities against our reference dividend-producing ETF portfolio and see what light this shines on building a long-term investment portfolio.

Asset Fund in this portfolio
REAL ESTATE (NYSEARCA:ICF) iShares Cohen & Steers Realty Majors
CASH CASH
FIXED INCOME (NYSEARCA:TIP) iShares Barclays TIPS Bond
Emerging Market (NYSEARCA:VWO) Vanguard Emerging Markets Stock ETF
US EQUITY (NYSEARCA:DVY) iShares Dow Jones Select Dividend Index
US EQUITY (NYSEARCA:VIG) Vanguard Dividend Appreciation ETF
INTERNATIONAL EQUITY (NYSEARCA:IDV) iShares Dow Jones Intl Select Div Idx
High Yield Bond (NYSEARCA:HYG) iShares iBoxx $ High Yield Corporate Bd
INTERNATIONAL BONDS (NYSEARCA:EMB) iShares JPMorgan USD Emerg Markets Bond

Portfolio Performance Comparison

Portfolio/Fund Name 1Yr AR 1Yr Sharpe 3Yr AR 3Yr Sharpe 5Yr AR 5Yr Sharpe
Retirement Income ETFs Tactical Asset Allocation Moderate 1% 20% 10% 79% 8% 60%
Retirement Income ETFs Strategic Asset Allocation Moderate -2% -5% 16% 81% 2% 7%
The 10 Cheapest Stocks in the Market -12% -46% 10% 33% -5% -17%

This table gives us a stark picture that although the three-year returns are reasonable, the longer- and shorter-term pictures are grim. I find that the graphs speak to me more fully.

(Click charts to expand)

Three-Month Chart One-Year Chart Three-Year Chart Five-Year Chart

The more detailed analysis and graphs show me an unpleasant picture. I see a down and to the right picture with these stocks. As I look at the holdings I see that WFR, HPQ, GLW and LLL are in the bottom but WFR is at 2.37%. Seeing that they all started at 10% of the portfolio, this is a significant drop.

I am not an expert in digging into the bottom of the bargain bin and I am probably too risk averse to try it. However, I think that more analysis is needed and I don't think that this selection can be applied blindly. I would want to dig into each of the companies to understand why they think they will recover and are really a bargain.

There is some merit in this approach and it has reasonable volatility even with lower returns but I think I would prefer to see if I can balance out some of the big drops in the 10-Year portfolio and look for some of the gains when the markets recover a bit.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclosure: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.

Source: The 10 Cheapest Stocks In The Market