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When the stock market began to tumble in late July, many investors swiftly gave up on equities and ran to the relative safety of U.S. Treasuries. But the paltry 2.1% yield on the 10-year T-note doesn't provide much comfort.
The recent market weakness and heightened risk of another recession isn't a reason to dump equities altogether, however.
For investors with a long-term time horizon, stocks look pretty attractive right now. The yield on the Dow Jones Industrial Average is currently 3.2%, and the earnings yield (inverse of the P/E ratio) on the S&P 500 is an attractive 8.4%.
While recent economic data has been weak and the odds of a recession have risen, there is still a good chance we're just facing sluggish economic growth for the next couple of quarters. If this is the case, these metrics point to plenty of upside for stocks.
Moreover, investors should realize that not all stocks will get beaten up if we do enter a recession.
Value is the Best Defense
Studies have shown that the best protection against the loss of capital in a down market isn't earnings growth but rather valuation. Those former high-flying stocks with irrationally high P/E ratios will get hit the hardest, no matter what their growth forecasts are. Stocks with low double-digit or single-digit P/E ratios, on the other hand, have much less downside risk.
Stocks That Bucked the Trend in 2008
Investors may be surprised to learn that there were 30 stocks in the S&P 500 that finished in the green in 2008. Granted, many were bought out earlier that year, and a few were biotechs with hit products. But take a look at some of the other top performers from '08:
- Family Dollar Stores (FDO): +36%
- Wal-Mart (WMT - Analyst Report): +18%
- AutoZone (AZO): +16%
- Hasbro (HAS): +14%
- General Mills (GIS): +7%
- McDonald's (MCD): +6%
- Waste Management (WM): +1%
Most of these are value-oriented retailers or consumer staples that were trading at reasonable prices before the crash.
But it's not just about value. Once a bull market resumes, investors want to own stocks with earnings growth potential so they don't miss out on the upside. The key is to find those stocks that offer both growth and value.
Stocks Bucking the Trend in 2011
The 14% drop in the S&P 500 since July 22 has sent shares of a lot of good companies lower, but it hasn't sunk all stocks.
Here is a list of value stocks that have held up quite well so far. They also each have strong earnings growth potential and should rise along with the market when it rebounds:
The TJX Companies, Inc. (TJX - Analyst Report)
Price Change Since July 22: -2%
12-Month Forward P/E: 12.5
This off-price retailer thrived during the Great Recession as middle-income consumers went bargain shopping. As the economy began to recover, the customers never left. The company continues to churn out positive same-store sales growth with the unemployment rate north of 9%.
Earnings estimates have been rising consistently over the last few months, sending the stock to a Zacks #2 Rank (Buy). Based on current consensus estimates, analysts expect 14% EPS growth this year and 12% growth next year.
Advance Auto Parts (AAP - Analyst Report)
Price Change Since July 22: +4%
12-Month Forward P/E: 11.2
Advance Auto Parts has held up strong in the weak market, much like it did in 2008. The auto parts retailer continues to benefit from customers holding onto their cars longer and repairing them rather than replacing them.
Analysts are currently projecting 19% EPS growth from AAP in 2011 and 14% growth in 2012. Despite this, shares trade at just 11.2x forward earnings, a discount to its 10-year historical median of 14.4x.
Wal-Mart Stores Inc. (WMT - Analyst Report)
Price Change Since July 22: -3%
12-Month Forward P/E: 11.1
Wal-Mart is another retailer that has held up well despite the carnage on Wall Street. The stock was one of few to thrive in 2008 too.
People may think Wal-Mart has no growth prospects left. Analysts disagree. Based on consensus estimates, analysts project 10% EPS growth this year and 9% growth next year. On top of this growth, the company pays a dividend that yields a solid 2.8%.
Schweitzer-Mauduit International Inc. (SWM - Snapshot Report)
Price Change Since July 22: -2%
12-Month Forward P/E: 8.5
Schweitzer-Mauduit International Inc. produces premium specialty papers primarily for the tobacco industry. This is certainly a defensive industry, but the company has excellent growth prospects too.
Analysts are projecting 22% EPS growth in 2011 and 29% growth in 2012. Estimates have risen significantly since the company delivered solid second quarter results on August 3. It is a Zacks #2 Rank (Buy) stock.
The Bottom Line
If you're worried about further stock market declines, think twice before exiting equities altogether. These value stocks have all held up well so far, and their growth potential provides plenty of upside if the market turns back around.
Todd Bunton is the Growth & Income Stock Strategist for Zacks Investment Research.