After analyzing the last 73 years of stock performance, Citi Research's Tobias Levkovich concluded that the average annual return for the S&P 500 is 14.6% when P/E ratios are between 14 and 16.
Currently, the S&P 500 is trading at 14.5 times earnings, which puts its multiple in range of the analyst's historical target for the largest annual returns. With that said, not all stocks are created equal, and investors must do more than simply assess P/E ratios to find good value.
Formula for value
If Levkovich is correct in his analysis and his theory holds true, the S&P 500 could see another year of substantial gains. Yet rather than investing in indexes or buying solely on the P/E ratio of a company, investors should seek companies that trade at a deeper discount to the broader market and have greater growth.
Theoretically, with this strategy, investors will be better protected with value investments, holding stocks with room to appreciate more than the broader market. With that said, let's take a look at a few stocks that fit in this category.
MRQ Revenue Growth
Q2 Industry Growth
Source: Company earnings releases; Thomson Reuters Proprietary Research. MRQ = Most Recent Quarterly.
Each of the five noted companies not only have lower P/E ratios than the broader market, but are also growing faster than their respective industries. Yet this alone doesn't make these stocks a buy.
What makes these stocks a buy?
Cisco is the behind-the-scenes company of Internet, telecom, and various technology offerings, including both hardware and software. Cisco is guiding for full-year revenue growth of 3% to 5%. Not to mention Cisco has a new line of network processors and recently refreshed its Catalyst Ethernet switches to secure its place as the top innovator among communication and networking companies. With an industry-best ecosystem in place, Cisco might prove to be a good long-term investment in a stable market.
Apache is a massive energy company, one that is discovering new fields and growing rapidly. During its last quarter, the company saw a 42% year-over-year rise in onshore liquid production. Moreover, its international business is performing strongly: Oil volume rose 3.1% in its last quarter, and seven new oil and gas discoveries were made in Egypt. This combination of growth, discovery, and value is what investors should seek in an energy investment.
The defense industry has not been among the brightest within the economy, especially given budget cuts through the sequester and conservative spending in the private market. Yet Raytheon has been a rare bright spot, stealing market share, cutting costs, and repositioning itself for a new-look market.
Earlier this year, Raytheon cut its full-year booking guidance by $400 million to $600 million due to U.S. budget cuts. While many thought this news could be fundamentally devastating, Raytheon has seen a boost in margins as its stock has soared nearly 40% in 2013. With that said, the stock remains cheap, and given low expectations, it might make a good long-term investment.
Corning is best known as the developer of Gorilla Glass, which is used on various smartphones and tablets including Apple's. However, this diversified company also operates in telecommunications with cable systems and optical fiber, pioneers tools for life sciences research and bioproduction, and even has a presence in clean-air technologies. This is a greatly diversified company with more than 150 years of experience that also happens to be cheap.
Lastly, the auto industry has thrived in 2013 as the European market has found a bottom and emerging markets continue to grow. Ford has seen impressive growth, trades at a deep discount to the broader market, and maintains an aggressive growth outlook throughout 2015.
Right now, the markets do seem to be trading with quite a bit of momentum. Yet there are smarter and more efficient ways to invest than assuming gains and buying into a broader market rally. Each company noted above is cheaper and faster-growing and has various qualities and operational strengths that could produce gains regardless of market direction.
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The article Can These 5 Value Stocks Outperform the Market? originally appeared on Fool.com.
Brian Nichols owns shares of Ford. The Motley Fool recommends Cisco Systems, Corning, and Ford. The Motley Fool owns shares of Corning, Ford, and Raytheon Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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