The Ultimate Signal to Load Up on Stocks?

The Ultimate Signal to Load Up on Stocks?
By Brian Richards and Tim Hanson April 20, 2009 Comments (22)

Legendary fund manager Peter Lynch famously said that if investors spend 13 minutes thinking about the economy, they've wasted 10 minutes.

Granted, Lynch wasn't managing money during a mega-macroeconomic crisis of the sort we're facing today. Plus, Lynch was likely being funny and hyperbolic -- surely some thought to macroeconomic events is useful for investors. (Anyone thought about buying a bank stock lately?)

So when we read the other day that lipstick sales rose more than 4% in 2008, we nodded our heads. Here it was again: the leading lipstick indicator.

How lipstick explains the economy

The ... what?

The leading lipstick indicator, is a scientific measure of the sale of, well, lipstick. The theory goes as follows: When times are tough, women will purchase lipstick rather than purchasing new threads or splurging for a new necklace. During the Great Depression, lipstick sales reportedly rose 25%!

The term was introduced by Estee Lauder (NYSE: EL) Chairman Leonard Lauder, who created it with nothing more than years on the job and astute observation.

Of course, lipstick sales are a comically unreliable economic indicator and lipstick alone can't save Estee Lauder investors from a downturn in consumer discretionary spending. But the obvious absurdity of judging the state of the U.S. economy by sales of this single product should at least suggest that other market "indicators" that judge our economy by a single metric are equally dubious.

New home sales? New home starts? Jobless claims? Non-farm payroll numbers? Durable goods report? They all make for interesting morning segments on CNBC, but they're unreliable, subject to revision, and not worth much without loads and loads of context. That means they're nothing but obnoxious noise to the ears of long-term-focused investors.

Turning to Buffett -- who else?

So imagine our surprise when we read a Fortune piece a few weeks back with the following headline: "Buffett's Metric Says It's Time to Buy."

Would Warren Buffett -- the patron saint of fundamental-focused value investing -- really suggest broad market indicators are relevant to a buy decision?

As it turns out, it can be.

His signal looks at total stock market value compared to gross domestic product. In 2001, when the percentage was over 130%, Buffett said that "if the percentage falls to the 70% or 80% area, buying stocks is likely to work very well for you."

At the end of January, Fortune reported, the ratio was at 75%.

The ultimate signal to load up on stocks?

Not so fast. This is, after all, the same Warren Buffett who told Berkshire Hathaway shareholders that "We try to price, rather than time, purchases."

He went on to say:

In our view, it is folly to forego buying shares in an outstanding business whose long-term future is predictable, because of short-term worries about an economy or a stock market that we know to be unpredictable. Why scrap an informed decision because of an uninformed guess? ... We have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.

In other words, it's foolish to abstain from buying because stocks in general appear "overheated," just as it's foolish to buy willy-nilly because stocks appear "cheap." Investing the Buffett way (which seems to have worked out pretty well for him) is about bottoms-up fundamental analysis with a focus on long-term competitive advantages.

Which brings us to an analogy

But look, it'd be daft to ignore the fact that it's better to go fishing at some times of the day than others and that that optimal time of day is determined by the weather and moon. If you go out at the wrong time with the best bait, your chances of hooking a fish are diminished; if you go out at the right time with nothing more than hook and a string, your chances are improved.

Similarly, in investing, you're more likely to earn great returns if you buy when stocks across the board are cheap than if you try to find the one or two bargains at a time when stocks across the board are expensive. And that's why some macroeconomic analysis can be useful: It tells you the best times to go fishing.

And today is one of those times. As we mentioned earlier, the market is broadly trading for just 75% of GDP, and on an individual level, many of the market's most impressive companies are trading at enormous discounts relative to their norms:

Company
Current P/E ..... 5-Year Average P/E

Google (Nasdaq: GOOG)
29.5 ..... 67.1
Johnson & Johnson (NYSE: JNJ)
11.6 ..... 17.8
Boeing (NYSE: BA)
10.5 ..... 20.9
Intuitive Surgical (Nasdaq: ISRG)
25.4 ..... 53.8
IBM (NYSE: IBM)
11.3 ..... 15.5
Disney (NYSE: DIS)
9.7 ..... 17.3
Data from Morningstar.

So, I buy those six stocks? Now, this doesn't mean that all of these stocks will beat the market from here on out, but it does mean that now is a great time to go fishing for top stocks in your portfolio.


Brian Richards does not own shares of any companies mentioned. Tim Hanson owns shares of Berkshire Hathaway. Google and Intuitive Surgical are Motley Fool Rule Breakers picks. Berkshire and Disney are Stock Advisor and Inside Value recommendations. Johnson & Johnson is an Income Investor selection. The Fool owns shares of Berkshire Hathaway. The Fool's disclosure policy says that if you're looking for fishing advice, try arkansasstripers.com -- but be careful when typing in the URL -- it learned the hard way and ended up having a talk with our IT department.

http://www.fool.com/investing/general/2009/04/20/the-ultimate-signal-to-load-up-on-stocks.aspx