What's really cheap in this market?

@Money October 20, 2011: 5:50 AM ET
You may have to look around a bit for a bargain stock to invest in, but you should be able to find one.

You may have to look around a bit for a bargain stock to invest in, but you should be able to find one.

(MONEY Magazine) -- Stocks have been sinking since April, so you'd think by now there would be an abundance of tempting shares to pick up on the cheap. Alas, you'd be disappointed.

Unlike in the financial crisis, when stock valuations sank to a 20-year low, real bargains are surprisingly hard to come by these days.

That's because this market has felt a whole lot scarier than it's actually been. The seemingly endless string of 4% daily swings you see on Wall Street masks the fact that equities are only now approaching bear market territory, defined as a 20% drop in price.

In early October, the S&P 500 closed as low as 19% off its April highs. That sounds bad, but stocks fell 57% during the financial panic.

True, some parts of the market -- financial stocks in particular -- are selling at "going out of business" prices. There's a reason for that, though. With their fates clouded by debt fears in Europe and proposed reforms in the U.S., many financial shares pose a big risk to your portfolio, especially if this faltering economy slips into a recession.

"There's an extraordinary number of wild cards and value traps out there," says Frank Barbera, co-manager of the Sierra Core Retirement Fund.

Mindful of these risks, MONEY interviewed more than a dozen money managers and strategists to find not just fallen stocks, but discounted parts of the market offering real value with an added sense of security.

Should this recovery go into reverse, the investments discussed below are unlikely to be hardest hit. Assuming the economy can find another gear, they'll go along for the ride.

Technology companies: A source of cheap growth

Tech may not be the first sector that comes to mind when you think of cheap pockets of the market. After all, these stocks are down just 4%.

But right now, tech is the "cheapest of the growth-oriented sectors," says S&P Capital IQ global equities strategist Alec Young. At a price/earnings ratio of 13.3, based on the past 12 months of earnings, tech is 55% below its historic price tag.

Based on analysts' forecast earnings (which are starting to tick down market-wide), tech's projected P/E of 11.8 is about on par with the broad market, even though the sector typically trades at a near-15% premium.

How is that possible? Tech firms have seen profits grow much faster than the rest of the market in 2011 -- and they should enjoy better-than-average growth in the long term, says Kevin Landis of the Firsthand Funds.

A decade ago, that faster growth was rewarded with sky-high P/Es. But "the model from the late '90s just doesn't hold anymore," says Mark Schultz, a fund manager with MTB Investment Advisors.

Won't tech earnings, which are keeping P/Es low, be decimated if the economy sours? Not necessarily. In the past five recessions, the median tech company's earnings declined 10%, compared with a 21% drop for the typical financial firm.

You can get the broadest geographical exposure through iShares Global Technology Sector Index (IXN), which sprinkles in foreign holdings such as Samsung and SAP alongside the usual domestic suspects, such as Apple and Microsoft. To stay inside the U.S., try Technology Select Sector SPDR (XLK), which owns all the tech stocks in the S&P 500.

When it comes to individual stocks, play it safe. Intel (INTC, Fortune 500) has been paying and raising dividends for years and now sports a yield of 3.9%. The stock trades at a projected P/E of 9 -- that's more than a 20% discount to its peers. Intel is still tagged an old-fashioned PC stock, when in fact it stands to benefit from the tablet and smart phone revolution.

More mobile devices in circulation means more servers are required, and Intel dominates the chip market for commercial servers. "Investors have underestimated Intel's growth potential," says Wells Fargo analyst David Wong.

Blue-chip multinationals: An emerging-markets play

The classic argument for investing in big, industry-leading businesses with a global reach used to be that they were safe bets. The new take: They offer a cheaper way to gain exposure to the highflying emerging markets.

Already, half of all revenue generated by S&P 500 firms comes from abroad, and a growing percentage of that haul is pulled in from fast-growing markets such as China, India, and Latin America.

Ask the Help Desk your investing questions

Due to their stability, large stocks normally trade at a premium. At the end of 2008, the S&P's projected P/E was 40% higher than the MSCI Emerging Markets index's. Since then, emerging-market shares have gained twice as much as the S&P, which is now at just a 20% premium.

The easiest and cheapest way to build a diversified portfolio of multinationals is through exchange-traded funds. U.S.-based multinationals can be found through Vanguard Mega Cap 300 (MGC), which invests in the 300 largest stocks in the domestic market. For multinationals with headquarters around the world, there's iShares S&P Global 100 (IOO).

With individual stocks, the bigger, the better. Take energy giant Chevron (CVX, Fortune 500). At a projected P/E of 6.7, its stock is 14% cheaper than rival Exxon Mobil (XOM, Fortune 500)'s, partly because of concerns that Chevron isn't expanding its energy reserves fast enough. Forester Capital Management analyst Jason McRae says those fears are overblown, noting Chevron's recent discovery in the Gulf of Mexico.

There are plenty of risks in betting on energy in a weak economy. But Chevron is well-positioned to sell into fast-growing Asian and Latin American markets. The firm also has a lower cost structure than its competitors, which makes it a safer bet when oil prices fall. During the 2007-09 recession, Chevron shares fell just 25%, vs. a 34% decline for the sector and a 38% drop for the S&P 500.

Medical equipment makers: Flying under the radar

The health sector has been plagued by uncertainties surrounding government reforms, yet some companies, such as medical IT leader Cerner, stand to be clear beneficiaries of the new laws -- and are trading at sky-high valuations as a result.

Other types of equipment makers, though, are being overlooked. Covidien (COV) sells supplies and devices for everything from basic medical care to major surgeries.

Though it faces a possible new medical device tax in 2013, the eventual increase in patient volume, thanks to expanding coverage, should boost sales to offset it, says Mark Finn, who runs the T. Rowe Price Value fund.

Three reasons to love the slowdown

At a P/E of 10.5, the stock trades at a near-20% discount to its medical equipment peers. Covidien doubled its R&D spending in recent years and has been restructuring its lineup -- efforts that temporarily weighed on profits but should eventually pay off.

Baxter (BAX, Fortune 500) also trades at a discount, thanks in part to the threat of new competition in the hemophilia market. But Baxter is making inroads in other areas, like home-therapy devices for dialysis patients, to go along with its highly profitable vaccines and biopharmaceuticals.

Prefer a fund? Check out Fidelity Select Medical Equipment & Systems (FSMEX), which counts Covidien and Baxter as its two largest holdings. The fund, which bets on equipment makers of all sizes, has beaten 90% of its peers over the past decade.  To top of page

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