The Bull Run that started in Mar 2009 has exceeded the rally which lasted from 1974-80. It is now the second-longest rally in nearly 60 years. Meanwhile, traditional value metrics currently exceed their long-term averages only marginally. However, the length of this Bull Run itself has led to speculation among market watchers that a bust may be in the offing.
Q Ratio
This has led to the renewed popularity of a number of valuation methods. One such method is Nobel Prize laureate James Tobin’s Q ratio. Going by this metric, the value of U.S. equities is 10% higher than the cost of replacement of underlying assets.
This is the highest level recorded since the dotcom bubble or the Wall Street Crash of 1929. In essence, the ratio has increased by 100% from its value in 2009 and is currently at 1.10.
One view is that the current high level is attributable to an extended phase of quantitative easing. This in turn has inflated asset prices which could result in great market instability.
Conflicting Viewpoints
Others are skeptical about accepting the Q ratio as a reliable measure of valuation. Some investors believe that trusting the metric would have kept them away from a bull run which has increased share values by around $17 trillion.
But those in favor of using the measure believe it reflects the current trend of companies preferring to initiate buyback programs instead of stepping up capital investment. Data from Birinyi Associates Inc. shows that buyback programs of $400 billion were declared till April this year.
Lower Capital Investment
Capital investment increased to record level last year. However, data from Barclays (LONDON:BARC) shows that an 11% increase has been recorded over the last two years, compared to a 45% surge in buybacks. The rise in equity prices has exacerbated this phenomenon, leading to the current level of the Q ratio.
However, the opposite view contends that the U.S. economy is more reliant on services at this point. Apple (NASDAQ:AAPL) and Facebook (NASDAQ:FB) are the face of the country’s corporates, replacing capital intensive sectors such as steel and railroads. This has reduced the importance of metrics like the Q ratio.
Our Choices
Despite opposing viewpoints, there is no denying the fact that voices across regulators and industry are worried about stock valuations. Both Janet Yellen and Berkshire Hathaway (NYSE:BRKa) CEO Warren Buffett have expressed their concerns on this issue. This has increased the importance of opting for investments which are attractively priced compared to their underlying value.
Below we present three stocks which are great value choices. Among the metrics used to identify these stocks are favorable price-to-earnings and price-to-sales ratios.
Additionally, with our new style score system we have identified the key statistics to pay close attention to and thus which stocks might be the best for value investors in the near term. The Value Style Score condenses all valuation metrics into one actionable score that helps investors steer clear of ‘value traps’ and identify stocks that are truly trading at a discount.
Our research shows that, stocks with Style Scores of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or #2, offer the best upside potential. Based upon the above criteria, we have selected three stocks. Not only do these stocks have a favorable Zacks Rank but also a value score of ‘A’ or ‘B.’
Asbury Automotive Group Inc (NYSE:ABG) is one of the largest automotive retailers in the United States. They sell, finance and service a diverse range of foreign and domestic automobile brands.
Asbury Automotive holds a Zacks Rank #1 (Buy) and has a Value Style Score of ‘B’. The company has expected earnings growth of 25% for the current year. The forward price-to-earnings ratio (P/E) for the current financial year (F1) is 15.90 and the price-to-sales ratio (P/S) is 0.38.
Marathon Petroleum Corp (NYSE:MPC) is a leading independent refiner, transporter and marketer of petroleum products. The company operates in three segments: Refining and Marketing, Speedway (Retail) and Pipeline Transportation.
Apart from a Zacks Rank #2 (Buy), Marathon Petroleum has a Value Style Score of ‘A.’ The company has expected earnings growth of 22.8% for the current year. It has a P/E (F1) of 9.67x and P/S of 0.31.
Aecom Technology Corporation (NYSE:ACM) is a leading solutions provider for supporting professional, technical and management solutions for diverse industries across end markets like transportation, facilities and government.
AECOM holds a Zacks Rank #2 (Buy) and has a Value Style Score of ‘A.’ The company has expected earnings growth of 27.3% for the current year. It has a P/E (F1) of 10.54x and a P/S of 0.39.
To end with another contrarian viewpoint, valuations could also have surged because other investment options are not attractive enough. However, concerns on this front remain, given the signals being sent out by a variety of indicators. Given their attractive valuations, these stocks would make prudent additions to your portfolio.