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Stock Market Doom-Busters

Use this screen to spotlight bargains in a gloomy market.

Haywood Kelly, 09/07/2010

Doom and gloom hang over the markets, so much so that it has become unpopular to voice a note of optimism. But let's do just that. The stock market has produced negative returns over the past 10 years, and, as we all know in our minds if not our hearts, it is following periods of such weak performance that we should expect better returns over the next 10 years. While we don't think stocks in general are ridiculously cheap, we do think the S&P 500 is about 18% undervalued. And we certainly see many stocks that we think are priced to produce excellent returns over the next decade. This screen is an attempt at bringing a few of these names to light.

( (Morningstar Rating = 5 stars)
Or Morningstar Rating = 4 stars And Dividend Yield % Current > 5%)

First off, we look for stocks that sport a high Morningstar Rating, meaning our analysts think the intrinsic value of the stock is significantly higher than the current market price. We either want a stock with a 5-star rating--our highest--or a 4-star rating and a great dividend yield. We know many investors seek income, and they are willing to give up a bit of potential total return to get it.

And P/E Ratio Current < 15

Next, we focus on two valuation metrics that have nothing to do with analyst forecasts. We first require a P/E ratio of less than 15. Fifteen is roughly the long-term average P/E of the U.S. stock market.

Free Cash Flow Year 1 > 10%

One of our favorite valuation metrics is the amount of free cash flow a company generates as a percentage of its market capitalization. If you acquired the equity of the firm in the open market, this percentage tells you what income stream you might expect from your purchase. Free cash flow is the amount of cash each year that's left over after the company has reinvested in its business. So, it's what is left over for owners (boards of directors in practice) to do with as they please.

Morningstar Financial Health Grade >= C

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