These days, many people look at the indexes such as the S&P 500 (SPY), Dow Jones Industrial (DIA) and Nasdaq (QQQ) and point out that the market must be overvalued because these indexes are either at or near their all-time high levels. While the indexes are at historically high levels, I am not convinced that the stocks are overvalued at the moment. I mean, there are some companies that are overvalued; however there are also many companies that are undervalued in today's market.
I understand that the last time the S&P 500 and Dow Jones Industrial indexes were at today's level, the unemployment rate was near 5%, the government's debt level was below $10 trillion and the economy was in much better shape than it is today. On the other hand, at the end of the day, the stock market is the market of companies, and when we look at companies, we see all-time-high profit margins, earnings and cash reserves. Currently, many companies are in the best financial shape of their history, even though we can't say the same about the government and many consumers.
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U.S. Unemployment Rate data by YCharts
Currently, the average trailing P/E ratio of S&P 500 index is around 14. The P/E ratio for the Dow index is 15. The forward P/E ratios for the two indexes are closer to 13. These P/E ratios are significantly lower than the historical ratios for these indexes which tended to be around 20. Then again, many could argue that the companies in the S&P 500 and Dow Jones Index don't enjoy the growth rates they once did because many of these companies are closer to maturity now than ever. This could be a fair point. However, there are still many companies demonstrating solid growth and failing to attract the attention of investors.
One example is Ford (F). Its current market value is $35 billion, whereas the company's cash reserves total $15 billion and long-term investments total $38 billion. While the company has a lot of debt, most of the debt belongs to Ford Financial, which offers auto loans to people that purchase cars from the company. Ford is looking at a forward P/E ratio of 7, which falls to 4 when company's cash reserve is excluded from the equation. Ford is undervalued by a large margin.
We also have particular industries where nearly all companies are undervalued due to fear or concerns. One such industry is the airline industry: US Airways (LCC) is currently trading for only 3 times its future earnings. Keep in mind that this excludes a possible merger with American Airlines (AAMRQ.PK) which will easily double the company's current revenue. The company's cash reserve of $2.5 billion surpasses its market value of $1.7 billion. The company could easily buy all its outstanding shares with its current cash.
Another company in the same industry is Delta Airlines (DAL) which also enjoys being grossly undervalued. The company's trailing P/E ratio is 7 and forward P/E ratio is 4. The company has $3.5 billion in cash and short-term investments, which is half of the company's $7 billion market value. Excluding this cash gives the company a trailing P/E ratio of 3.5 and forward P/E ratio of 2. I believe that there are many opportunities in the airline industry, but I would be cautious about putting all my eggs in one basket as airliners tend to experience bankruptcy more often than companies in the other industries. This probably explains the low valuation of these companies.
Heavy industries also present a lot of investment opportunities. Caterpillar (CAT), Deere (DE) and Boeing (BA) are three of the undervalued companies that engage in heavy industry. Caterpillar and Deere are both looking at a forward P/E ratio of 9, while Boeing is looking at a forward P/E ratio of 15 for 2012 and 12 for 2013. All of these companies are flooded with cash, and excluding cash from the equation would bring their P/E ratios down even further.
Furthermore, the financial industry also presents many companies that can be bought at a great discount. Currently, many banks and financial companies are trading for less than their book value, including but not limited to Bank of America (BAC), MetLife (MET) and Citigroup (C).
I just don't see how the market is overvalued when many companies trade for below or near their book value, have single digit forward P/E ratios, are flooded with cash and enjoy all time high profit margins. Currently, companies are living their golden age, and there are many companies that are grossly undervalued in the market.