With Stock Markets at Record Highs, Is There Still a Smart Way to Buy?

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The Dow Jones Industrials (^DJI) and the S&P 500 (^GSPC) have both climbed to new record levels recently, producing gains of almost 20 percent so far in 2013 as of July 18. Yet given how far stocks have come since the market's meltdown in 2009 -- the S&P 500 has risen more than 150 percent since then -- some investors worry that buying stocks now is bound to turn out badly.

Before you swear off stock investing entirely, you should realize that not all stocks have equal prospects. Even with the market trading at highs, some stocks haven't seen the same gains as the Dow and S&P. Moreover, even some stocks that are at or near their own record levels have the fundamental business strength to justify their share prices.

Let's take a look at these two categories with some tips on how to find good stocks even with markets at record highs.

Strategy 1: Focus On Beaten-Down Industries.

Bull markets rarely take every stock higher. Inevitably, you'll find some companies or industries that suffer setbacks and end up being big laggards. If the conditions that created those setbacks reverse themselves, though, then beaten-down stocks can catch up with market gains quickly.

We've already seen that phenomenon with homebuilders' stocks. From 2009 to 2012, even as the rest of the economy started picking up steam, homebuilders performed badly as the housing market kept failing to post lasting home-price gains. In 2012, though, housing finally started showing considerable gains, with home prices rising double-digit percentages in the past year.

One possible place to look for a turnaround today is in commodity stocks.

A weak global economy has reduced demand for industrial metals like aluminum and copper, sending prices plunging and hurting producers like Alcoa (AA) and firms that that mine and refine those metals like Freeport-McMoRan Copper & Gold (FCX). Also, with fears of inflation and economic instability having significantly abated, gold and silver have seen dramatic price declines, and precious-metals mining stocks like Goldcorp (GG) and Barrick Gold (ABX) have fallen sharply as well. Those adverse conditions could last well into the future, but eventually, if the global economy starts to regain its strength, then commodity demand should rise and pull commodity-related stocks up.

Keep in mind, though, that turnarounds can take a long time to materialize. If you don't have the patience to wait for other investors to see the promise of a struggling industry, then this strategy could leave you frustrated for months or even years into the future.

Strategy 2: Seek Out High-Flying Values.

Just because a stock trades at all-time highs doesn't mean it's not a good value. If a company expects its sales and income to grow at a fast rate in the future, even richly priced shares don't always reflect the full value of the stock.

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As an example, look at fashion giant VF (VFC), which is the company behind popular brands that include Timberland, North Face, Vans, and Wrangler and Lee jeans. The stock has soared by more than 30 percent this year to all-time highs, but its earnings have more than kept pace. With expected double-digit percentage earnings growth over the next several years and the ability to capitalize on the rapidly expanding sports and fitness market for athletic apparel, VF has plenty of room for further gains given its relatively modest earnings multiple in the mid to upper teens.

One thing to remember about high-flying stocks is that they often incorporate very optimistic expectations, and so even the slightest misstep from a company can send its stock plunging. Nevertheless, by choosing high-growth stocks that trade at reasonable valuations, you'll reduce that risk somewhat while earning better gains if things work out well for the company.

Don't Stop Buying; Just Buy Smarter

Regular investing is an essential element of ensuring your long-term financial success, and even with stocks at record highs, you shouldn't give up on your regular investing plan entirely. However, by focusing on stocks that have a better chance of posting further gains from their current levels, you can reduce the risk level in your investment portfolio while still remaining on course to benefit from the long-term potential that the stock market offers.

Motley Fool contributor Dan Caplinger owns shares of Freeport-McMoRan Copper & Gold. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold.

With Stock Markets at Record Highs, Is There Still a Smart Way to Buy?
(DE) trades at close to $86, and the $97.89 consensus price target implies upside of almost 14%. Deere comes with a 2.3% dividend yield. The 4 million shares in Buffett's war chest are worth about $344 million, but will be worth almost $400 million or so if you include the dividends in a year, if Wall Street is right. Buffett might agree with the most optimistic analyst target out there of $120 per share, since this machinery giant trades at only about 10 times earnings.
GM (GM) is still a fairly new position for Team Buffett. Buffett probably thought he would get an index-related bounce, and his 25 million share are worth about $850 million. GM's stock has risen to more than $34, which still leaves more than 15% upside to the consensus price target of $39.53. Buffett likely foresees years of auto sales growth ahead, and GM's forward earnings multiple of 10 times earnings is just a tad cheaper than the dividend-paying Ford Motor (F) at almost 11 times earnings. The highest analyst target out there is actually above $50, although we would caution that GM pays no dividend.
J.P. Morgan (JPM) is a personal stock holding of Buffett, even though Wells Fargo & Co. (WFC) keeps becoming a larger and larger stake for Berkshire Hathaway every quarter. We are not sure how much money Buffett has put into J.P. Morgan himself because it has not been disclosed. With shares just under $53, the implied upside is close to 8% here, and that was the most upside in the Buffett banking and financial giants. Buffett himself likely agrees more with the highest consensus target of $66, since this top bank trades at less than 10 times earnings and yields almost 3%.
Coke (KO) has retreated to under $41 from $43 in this latest market pullback, but the implied upside to the $46.20 price target is now about 13.5%. Buffett has been a long-term holder here, and his position is worth close to $16 billion. The top analyst target is $50 and the dividend yield is about 2.8%. Buffett has had a stake in Coca-Cola so long that he likely couldn't care less that a beverage stock trades at about 19 times expected earnings.
IBM (IBM) is still somewhat new to the Buffett portfolio, and it's a larger position, worth close to $14 billion, for more than 68 million shares. The $203 share price implies almost 10% upside to the $222 price target. IBM keeps buying back stock at a rapid pace but only pays a 1.8% dividend yield. It trades at about 12 times earnings, and the highest price target from the analyst community is $250.
Berkshire Hathaway's position in National Oilwell Varco (NOV) has grown to almost 7.5 million shares, with a current market value of more than $500 million. It trades at about $69.25, and that implies about 19% upside to the $82.58 consensus price target. The dividend yield here is lower than most Buffett stocks at only about 1.5%, but its valuation in the oil infrastructure market is not excessive at about 12 times expected earnings. Buffett's new portfolio managers probably think that the highest analyst price target of about $93 is closer to the truth, considering its dominance oil and gas infrastructure.
Buffett's stake in Precision Castparts (PCP) is worth about $420 million, but the $211 share price implies upside of about 13.5% to the consensus $239.60 price target. Its dividend is too small to matter, although it was hard to not notice the street-high price target of $280 for the metal components and products player.
Berkshire has a lot riding on it's stake in Procter & Gamble (PG), which is valued at about $4 billion, although this is a lower stake than it had been in the past. Now that shares have pulled back to about $76.85, the implied upside that remains here is just over 10% to the consensus target of $84.78. Buffett likely agrees with the activists that the CEO change may help, and Buffett probably would think that the street-high target price of $95 is perhaps better for the long-term, as the consumer products giant recently tried to break out to higher prices. Buffett might also say that he is happy to get that 3.1% dividend yield while he waits. He might agree that 19 times earnings is too much in general to own a consumer products stock, but he has said over and over again that he'll pay up for quality.
Berkshire Hathaway's stake in Phillips 66 (PSX) was added to after the Conoco spin-off, its 27.16 million shares are worth more than $1.7 billion. The $63.75 share price implies upside of more than 13% to the $72.15 share price. Buffett went out of the way to talk up this holding in 2012, and the dividend is about 1.9%. This refiner and marketer trades at only eight times earnings, and the street-high target price is $85.
Berkshire has a rather small position in Verisk Analytics (VRSK) --  less than $100 million, making it one of the new portfolio manager's positions. Now that shares are down around $58, this implies about 12% upside to the $65.18 consensus price target. This analytics outfit for financial, insurance and health care decision-making does not pay a dividend, but the highest analyst target is up at $71 here.

(USG) is a strange position for Berkshire because the equity value of the stake of more than $400 million is undercounted to the actual control that the company has here. The $24.25 share price has corrected from more than $30, but that means there's a 27% implied upside to the $30.82 consensus price target. The common stock pays no dividend, but there is over 50% implied upside to the street-high $39 price target. The home builder products company still trades at a very high multiple of about 40 times earnings, but this has been a stake for years and years, while shares have been both much higher and much lower.

Photo: Davidneubert.com, Flickr.com

Some of the stocks from the Buffett portfolio have quite a lot of implied upside, and other upside winners are only about at-market upside risks. Stocks have pulled back in recent days and volatility has returned with a vengeance.
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