Is the Stock Market Overvalued?
Two Undervalued Stocks
A Final Thought
Will the Stock Market Go Up or Down?
I am often asked whether the stock market is going to go up or
down in the weeks or months ahead. No one knows for sure which
direction the stock market is going to take, because many
variables influence the stock market. Unforeseen events can
negate the best research and analysis.
I cannot predict what the stock market will do next, but I
know I can enhance my investment performance if I invest more
conservatively when the stock market is high, and take advantage
of bargains when the stock market is low. This, of course, begs
the question, "How can we gauge what is high and what is
Some investors are capable of assessing the market's current
status by studying charts. I prefer to determine whether the
stock market is overvalued or undervalued by "running the
How to Evaluate the Market.
I start by calculating a few ratios. The price to earnings
ratio (P/E) is simple. First, I add up the prices of all 30 of
the Dow Jones stocks. Then I add up all of the earnings per share
). Finally, I divide the total prices by the total EPS to find
the P/E. To determine the EPS, I use the past two quarters and
estimates for the next two quarters. The current P/E is 14.4. The
historic P/E for the Dow Jones Industrial Average for the past 10
years is 13.9. Therefore, I can conclude that the current stock
market as measured by the P/E for the Dow is slightly overvalued
at 14.4 compared to the historic average of 13.9.
Not only do I calculate a simple P/E ratio to gauge whether
the stock market is overvalued or undervalued, I also compare
current and historic ratios for price to sales, price to cash
flow, price to book value and dividend yield. In addition to
being slightly overvalued according to price to earnings, the Dow
is overvalued using price to cash flow ratios and dividend yield.
I conclude that the market is a tad higher than it should be
right now. Therefore, caution is advised, although the Dow Jones
Industrial Average could rise another 2,500 points before
becoming clearly overvalued.
What about the future? By using some forecasting tools and
formulas I developed, I can calculate that the overvalued and
undervalued ranges for the Dow Jones will be 17,129 and 11,907
for the next two years. Notice I didn't predict that the Dow will
reach either extreme, but if I had to guess, I would predict that
the Average will stay in the mid part of the range.
As I mentioned previously, I want to know if the market is
overvalued or undervalued so that I can invest cautiously when
the market is too high and invest aggressively when the market is
low and undervalued. After the market's recent run-up, I advise
using some caution. As a long-term investor, though, you should
look for the market to move higher and continue to buy
Which Stocks are Undervalued and which are
The recent stock market advance has pushed many stocks well
past undervalued status, and some are now overpriced and should
be sold. Today I checked my database of 1,000 companies to find
which stocks are undervalued and which are overpriced. According
to my calculations, 92 stocks are currently undervalued and are
buy candidates, and 285 stocks are overpriced and probably should
There are many ways to determine whether a stock is
undervalued or overvalued. S&P (Standard & Poor's) and
other investment services provide ratings to indicate which
stocks are considered undervalued. Most brokerage websites
provide access to S&P data which can be screened to find
stocks that fit your criteria. Stocks with S&P Fair Value
Ratings of 4 or 5 are undervalued.
With the U.S. and global economies growing at an agonizingly
slow pace, I searched for companies that are bucking the trend:
companies with exceptional growth prospects for the next 12
months and beyond.
Based upon my forecasts, I expect 17 undervalued companies to
increase their earnings by 15% or more during the next 12 months.
In addition, the companies will likely produce at least 15%
earnings growth per year during the next five years.
Undervalued companies with exceptional growth prospects will
very likely outperform the stock market during the next one to
two years. If you would like a list of my 17 elite undervalued
companies, please send me an email at firstname.lastname@example.org and I'll send
you the list for free!
The following two healthcare companies clearly stand out in my
list of 17 undervalued companies.
(ACT: Current Price 97.85; Max Buy Price 98.83), formerly Watson
Pharmaceuticals, is a leading manufacturer of generic drugs whose
goal is to produce difficult off-patent drugs. The merger of
Watson and Actavis Group in October 2012 created this leading
U.S. generic drug company. Generic drugs account for about 75% of
revenues, and their use is growing fast.
Actavis markets 160 generic drug products in the U.S. and 54
in Canada, comprising a wide range of therapeutic categories.
ACT's international division, Arrow Group, markets 50 generic
products in Europe, Asia, South Africa and Australia.
Actavis currently has about 130 Abbreviated New Drug
Applications (ANDAs) with the U.S. Food & Drug Administration
(FDA). An additional 500 applications are on file outside the
U.S. The company sells its products primarily through
distributors and chain drug store operators, including McKesson
Actavis' sales will likely advance 27% and EPS will jump 30%
during the 12 months ending 3/31/14. The recent merger and
promising new product introductions will spur results. In
addition, the Patient Protection and Affordable Care Act will
boost sales and earnings in 2014 and beyond. With a price to
earnings ratio (P/E) of 12.1 times my forward 12-month EPS
estimate of 8.12, ACT shares are low risk and clearly
I expect ACT shares to reach my Min Sell Price of 129.65
within one year.
(UTHR: Current Price 61.16; Max Buy Price 61.96), Based in Silver
Spring, Maryland, United Therapeutics develops and markets
therapeutic products for patients with chronic and
life-threatening illness, including cardiovascular disorders,
cancer, and infectious diseases. United Therapeutics is gaining
market share and has become the U.S. leader in the pulmonary
arterial hypertension (PAH) market with its highly successful
Remodulin, Adcirca and Tyvaso treatments. In addition, exciting
new products are being discovered in the company's
The U.S. Food and Drug Administration (FDA) acknowledged the
resubmission of the new drug application for treprostinil
diolamine extended-release tablets for the treatment of pulmonary
arterial hypertension. The FDA classified the resubmission as a
complete, class 1 response to FDA's October 23, 2012 complete
response letter. United's previous submission had been rejected
by the FDA.
Sales and earnings have soared during the past two years, and
United is well-positioned to produce solid growth in 2013 and
beyond. Sales will rise 12% and EPS will advance 16% during the
next 12 months ending 3/31/14. New treatments for unmet clinical
needs are under development. Expansion into foreign markets also
offers great opportunities for the company.
At 9.1 times my forward EPS estimate of 6.70, UTHR shares are
a bargain. New drugs could boost results considerably higher than
my forecast. United pays no dividend and is medium risk. UTHR's
share price will likely rise to my Minimum Sell Price of 101.57
within two years.
My Final Thought
Investing is a serious business. We are investing our life's
savings, saving for college expenses and retirement, and putting
money away for many other important life events. Just as serious,
though, is our state of mind toward each other and toward the
world we live in. The tragic events in Boston re-emphasize what
can go wrong when anger and misconceptions collide.
How did these two young men get the idea that the United
States of America is a terrible place to live? I don't know, but
Boston is coming together because of this tragedy. Neighbor is
helping neighbor. Friend is helping friend. Moms and dads are
No matter where you live, we can all come together. We can all
begin to set better examples and help our children, friends,
co-workers, and even strangers to become kind and friendly.
Together and individually, we can make this a better world in
which to live.
Cabot Benjamin Graham Value Letter