The Baseball Player Who Mastered the Market

There is one ball player out there who has cracked the nut of investing -- a guy who grasps the underlying complexities of the financial world with astonishing ease. Even though I've never heard him utter even one market catch phrase or a single financial buzzword, it's clear that this guy just gets it.

Do you know who he is? Let me help you out.

First, I assure you his name does not rhyme with Denny Lykstra -- who clearly doesn't get it.

I doubt that the guy I'm thinking of has ever played with a Bloomberg terminal, made a call on a stock, or managed a dime of anyone else's money. Yet this man is able to grasp abstract concepts like risk and uncertainty better than most risk-management officers on Wall Street do.

His name is Yogi Berra, and he's awesome.

Admit it. You already like him.
If you made a list of quotable people who also happen to be athletes, this name should fall near the top. But there's a whole lot more to Yogi Berra than just an amusing quip or a clever taunt. He seems to harbor an innate understanding of risk and chance. Examine the following statements:

• "The future ain't what it used to be."
• "A nickel ain't worth a dime anymore."
• "I knew the record would stand until it was broken."

In three terse sentences, Berra captures the central ideas behind a few big investment problems:

• Predictions are rarely accurate.
• The dynamic between price and value is always changing.
• When you're dealing with an uncertain future, nothing is written in stone.

These are basic yet crucial investing principles. And although Yogi hasn't physically mastered the market -- at least, that I know of -- his ability to speak with this kind of elegant simplicity is unique.

What would Yogi think?
This makes me wonder what Yogi would say about a recent article published in the Wall Street Journal, which discussed the failure of Monte Carlo models (and the financial advisors using them) to anticipate the financial disaster of late.

The Monte Carlo simulation, for those who don't know, takes various inputs, runs them against randomized simulations, and then throws the results together into a statistical model. If you haven't heard of this process, perhaps you should ask your financial advisor, wealth manager, or investment bank about it, because someone who touches your money has probably been using this software to model risk in your portfolio. The results of these simulations are then used to answer a rather crucial question: Will you have enough money to survive once you retire?

Suspicion tells me that Yogi might have a problem with a machine that's meant to predict the future.

Despite the elaborate complexity of these models and all of the theoretical science involved, financial simulators are all flawed in one simple way: The future is, by definition, unknown. So you can't really model it. You can try, but it won't work.

Yogi already knows this. Sadly, most financial advisors don't.

Where it all went wrong
Humans and models together failed to anticipate our recent market collapse. Don't blame the models, though. After all, a simulator can be only as good as the person who calibrates it.

In addition to false assumptions regarding "normalized" statistical distribution of stock market returns (and I promise not to get more technical on you than that), I'm nearly certain that the folks who coded these simulations -- as well as those using them -- further rationalized that the U.S. markets were too stable and had too many fail-safes in place to experience a 50% drop such as the one we've just experienced.

And therein lies the problem. Of all people, the individuals calibrating these simulations should be the most familiar with how probable a 50% market drop truly is. And regrettably, they were not.

The market does crash
Drops on the scale of 50% are unusual, but they're not out of the realm of possibility. In fact, they happen a lot more frequently than we'd like to believe. Think about it: We've had numerous double-digit swings in this decade alone.

I can't help feeling that the simulations as they were set were a lot like a flight simulator that doesn't offer a "landing in a thunderstorm" scenario. Thunderstorms happen more often than 50% drops in the stock market do, but either one can result in the same thing: bad, bad landings.

If you examine the historic returns of the stock market, you'll ultimately conclude that if you're alive on this planet for more than 20 to 30 years, it's more than likely you'll experience a huge drop in the stock market. So why the heck didn't these models account for that fact?

Choose to acknowledge reality
The reality is this: Massive volatility is here, always has been here, and probably always will be here.

Please forget doing what these financial advisors are trying to do. Don't attempt to predict the future and make investments based on these predictions. No one really knows what the future is going to look like, even (and perhaps especially) the experts. The market will go up, and it will go down -- everything else is uncertain.

Next, don't trick yourself into thinking that any individual assumption about the future, no matter how safe it may seem, is a 100% lock. Need evidence? Check out some of these more recently infamous assumptions:

Stock	Assumption	2-Year Return
General Electric (NYSE: GE)	Great investment. Safe. Stodgy. A well-insulated superconglomerate.	(72%)
Fannie Mae (NYSE: FNM)	Largest owner of American mortgages. Enjoys pseudo-governmental protection and has direct access to the strongest, most-secure assets in the world -- American homeowners.	(99%)
AIG (NYSE: AIG)	Biggest provider of insurance services in the world. Safe. Conservative. Profitable.	(99%)
Citibank (NYSE: C)	Largest global bank, offering a full suite of financial services. Extremely well run and very well protected.	(95%)

Five years ago, someone would have provoked laughter at the suggestion that these five businesses would end up in their current state. Perhaps you should consider similar assumptions that people are making about supposedly supersafe stocks ... whether it's McDonald's (NYSE: MCD) or Wal-Mart (NYSE: WMT) or whatever. It's really not much different in these cases. Apple (Nasdaq: AAPL) may seem invincible, but it's not. Anything can happen.

Three steps to control risk
It's in your best interest to calibrate your own portfolio to account for the stock market's lack of certainty. How?

1. Don't make outsized bets on any one investment if you can't afford to lose 100% of your money. It's the stock market, folks. Your money could all get wiped away before you can do a thing about it.
2. Next, don't count exclusively on having one or two things going right with your investment, when so many things can go wrong. Avoid situations in which a precious small number of things must go right for your investment to succeed.
3. And finally, stay away from investments that you truly don't understand. You can never find a sure thing, but you can certainly push the odds in your favor.

The Foolish final word
Yogi Berra once said, "It ain't over till it's over."

If you're investing as if the future is a foregone conclusion, then you might just find yourself the unfortunate victim of a bad assumption. Don't let that happen. Diversify yourself across a bed of the world's best companies. No one can guarantee success, but the odds are substantially in your favor if you at least diversify. And that's how you make more money without seriously risking losing all of it.

5 Cold Stocks Heating Up

When a stock's share price is lower than a North Dakota thermometer in February, investors tend to give it the cold shoulder. But as the market warms to a stock's prospects, its price can heat up in a hurry. Alas, you can rarely tell that a stock is melting investors' hearts until after it's made that upward leap.

Taking the market's temperature
But Motley Fool CAPS' proprietary ratings, aggregated from the opinions and accuracy of 135,000-plus members, offer a great way to monitor investor sentiment. Following a CAPS rating trend can help us determine the best time to invest. Let's look at previously rated one- or two-star companies that have recently enjoyed a bump in investor confidence, and see whether they're truly heating up -- or headed back to the deep freeze.

Company	CAPS Rating (Out of 5)	Recent Price	EPS Estimates (Next Year/Year After)
Blackstone Group (NYSE: BX)	***	$9.13	$0.33/$0.87
Cymer (Nasdaq: CYMI)	***	$29.23	($0.12)/$1.15
Fuel Systems Solutions (Nasdaq: FSYS)	***	$19.12	$1.40/$1.74
Netflix (Nasdaq: NFLX)	***	$42.19	$1.72/$2.09
Xerox (NYSE: XRX)	***	$6.32	$0.51/$0.69

Source: Motley Fool CAPS.

Obviously, this is not a list of stocks to buy -- just a starting point for further research. Yet if some of the best investing minds are taking notice of these stocks, maybe we should pay attention, too. 

The sun's always shining somewhere
This isn't the first time Netflix has been the subject of buyout rumors -- and at the hands of Amazon.com (Nasdaq: AMZN), no less. Yet just as previous rumors proved to be just that, the rationale for a buyout this time seems even less grounded in reality.

If Netflix executives had a "grab the cash with both hands" mentality, the scenario might make sense. Amazon is positioning itself to be a top contender for streaming video, and Netflix CEO Reed Hastings has admitted that the death of the DVD will eventually become reality. So getting while the getting's good, when your stock has more than doubled from its low point last October and you're still riding high, might make sense on some level.

Except that Hastings and company haven't shown themselves to be particularly concerned about competing technologies, and no rival has yet managed to knock Netflix from its pedestal. Blockbuster (NYSE: BBI), once a credible threat, today barely clings to relevancy. Amazon, Wal-Mart, and a host of others have tried and failed, too. The closest thing Netflix sees as a threat is plucky kiosk video vendor Redbox, but even then, I wouldn't worry too much. Videophiles are more likely to use Redbox as an adjunct to their Netflix subscription than as a replacement for it. As Foolish comrade Rick Munarriz wrote, Netflix can afford to say "no thank you" to this offer -- should it materialize.

Highly rated CAPS All-Star member TheOriginalBK thinks investors still have plenty of opportunity to profit from Netflix, even at this late stage, in light of the many deals it's putting together.

I am way late to this party, but hey, it's a good party. I am not a huge movie person, I watch maybe 2 a month. I also very rarely know when I'm going to be able to do so. [It's] so nice just to have a movie sitting around ready to watch whenever. And the plans are more reasonable than paying for each movie like cable/dish offerings. With the partnerships for streaming movies developing quickly, I think this party will continue for a while ....

Not everyone is a Netflix partisan, however. CAPS member christian8181 believes that as the value proposition of what cable and satellite have to offer becomes more widespread, the benefit of a Netflix subscription diminishes. "on demand cable, dvr, fierce competition between cable/satellite companies given way to nice promotions, bundle packages cutting costs further ... why do I need Netflix anymore when $10 more each month gives me more value with the cable company?"

Will Housing Bottom in … 2011?

That is the likely scenario according to a report published on Tuesday by mortgage insurer PMI Group, according to which 28 of the country's 50 largest metropolitan areas face high odds of lower home prices in the first quarter of 2011 (vs. now).

Unemployment takes the relay baton
The areas with the worst odds of home price drops are in states that were in the eye of the housing bubble, including California and Florida, but the report notes that the increase in risk "is now largely being driven by rising unemployment and foreclosure rates."

PMI's forecast contradicts Yale economist and housing guru Robert Shiller. Last week, commenting on a lower-than-expected drop in the Case-Shiller home price index in the month of April, he said: "My guess would be that home prices are going to level off -- they're not going to keep falling." Still, he cautioned "it's hard to predict" a speculative market. So, who is correct?

A sector at risk: Consumer discretionary
Although Shiller is well-informed and appropriately skeptical, I think we may witness something closer to PMI's scenario due to persistent high unemployment. If that turns out to be the case, it isn't good news for companies that rely heavily on a buoyant U.S. consumer, particularly those that look somewhat expensive:

Company	Forward P/E	YTD Price Return
Amazon.com (Nasdaq: AMZN)	44.5	47.5%
Sears Holdings (Nasdaq: SHLD)	30.0	53.7%
Marriott (NYSE: MAR)	21.7	1.4%
Abercrombie & Fitch (NYSE: ANF)	19.0	1.3%
Starbucks (Nasdaq: SBUX)	17.0	37.1%
Home Depot (NYSE: HD)	16.7	(2.7%)
Yum! Brands (NYSE: YUM)	16.1	9.5%

Source: Capital IQ, author's calculations.
Note that I do not have a view on whether these stocks are overvalued -- they were selected systematically because they are statistically expensive based on a single metric.

Although economists can argue about the magnitude of the "wealth effect" according to which changes in home values affect consumption, I think there is little doubt that further home price drops would affect consumer confidence and, ultimately, the level of consumption. In that environment, defensive sectors (health care and consumer staples), which lagged many other sectors during the second-quarter rally, may find favor again. 

The Worst Stocks to Buy Today

If you missed the best week to buy stocks, you might be kicking yourself. I know I am. The market is, after all, up 32% from its March 9 low.

But just as it was unwise to panic-sell when everyone around us was losing their heads, it's equally unwise to panic-buy now that the market is in rally mode.

The sudden switch in investor sentiment -- from stocking up on gold, potatoes, and ammunition in early March to "everything's going to be OK" just four months later -- is reason enough to be skeptical of this rally.

The key to investing success, as always, is being patient and continuing to buy quality companies trading at good values. This rally, however, has largely been led by inferior companies that had been heavily shorted and left on death's doorstep.

Trying to hitch a ride on them now may be tempting, but proceed with caution.

Garbage pail kids
Following a string of notable bankruptcies, from retailers like Circuit City to once-vaunted financial institutions like Lehman Brothers, investors rightly began to wonder who would be the next to fall.

Indeed, the futures of a number of well-known but heavily indebted American institutions were in serious doubt. International Paper (NYSE: IP) and MGM Mirage (NYSE: MGM), for example, were at one point trading at $4 and $2, respectively. Both companies have naturally been under tremendous pressure to shore up capital and responded by selling assets, refinancing existing debt, and -- in the case of International Paper -- slicing the dividend by 90%.

Since March 9, International Paper shares have gained 237% and MGM Mirage 154%. These are just two examples of the recent "dash to trash" in this market rally. Consider the profile of the 340 US-based companies with current market caps over $300 million that have gained more than 100% since March 9:

	Debt-to-Equity	Net Income (LTM)	Return on Capital
Median	90%	($47.9 million)	4.1%

Source: Capital IQ, as of July 6, 2009.

Put simply, this rally's been largely led by weak hands. While it may be tempting to jump on this bandwagon now, these are the worst stocks to buy today, especially since we're not completely out of the economic woods just yet. If things take a turn for the worse again, chasing these stocks could be a very costly mistake.

Instead, investors (as opposed to speculators) should focus on profitable companies that generate free cash flow, that have a track record of rewarding shareholders with efficient use of capital, and that have strong balance sheets.

These are the types of companies that will emerge from macroeconomic turmoil even stronger than before.

Names, please
Despite the recent rally, there are still many quality companies trading at reasonable valuations that are worth further research, including the following.

Company	Price to Free Cash Flow	Return on Equity
Cisco Systems (Nasdaq: CSCO)	10.4	20.1%
Procter & Gamble (NYSE: PG)	13.6	18.5%
Hewlett-Packard (NYSE: HPQ)	9.6	19.6%
Oracle (Nasdaq: ORCL)	13.4	23.2%
Adobe (Nasdaq: ADBE)	13.1	16.3%

Source: Capital IQ.

Given their size, you shouldn't expect any of these companies to become a six-bagger in a matter of weeks the way Ruby Tuesday did recently, but you can sleep a little better at night knowing your management team isn't slashing dividends or selling assets just to pay the bills. In fact, Oracle just announced its first regular dividend, and in April, Procter & Gamble marked its 53rd consecutive year of increased dividend payouts by boosting its payout 10%.

Foolish bottom line
After sustaining significant losses over the past year, it may be tempting to chase after struggling companies that have had huge run-ups in this rally, but do your best to not lead yourself into that temptation. If buying distressed stocks was a gamble in early March, it's an even bigger gamble now that many have soared in price. Another downturn in the market and they could be going from heroes back to zeroes -- literally.

The market's still a volatile place, so remember to stay patient and focused on buying the companies that actually turn a profit, have strong balance sheets, and are led by top-notch management. Begin by building a watchlist of stocks you'd love to own if they fall another 10% to 20%. This way, you're ready to strike when the market gives you the opportunity.

Wall Street's 10 Favorite Stocks Right Now

On the heels of some seriously ugly macroeconomic news and last year's market plunge, investors withdrew more than $55 billion from their mutual funds in just the first three months of this year. Things are scary out there, and investors are (understandably) freaking out.

All that pressure got you down ...
When Wall Street's all sunshine and roses, everyone is a stock market genius. Only during the uncertain times do most investors seek "expert" advice. That often means pulling up Yahoo! Finance to see what analysts think of their stocks.

Despite my long-standing misgivings about the worthiness of Wall Street's advice -- especially now, after a year of watching their business sense nearly destroy our entire economy -- I wanted to find Wall Street's 10 favorite stocks.

So I built a screen using Capital IQ, a great institutional software package. I sought out the stocks with the most analyst "net buy" recommendations, with net buys defined as buys minus sells.

Here they are:

Company	Analyst Net Buy Recommendations	% Owned by Institutions*	Market Cap
Activision Blizzard	18	45%	$14.6 billion
Enterprise Products	14	23%	$11.9 billion
American Eagle	13	65%	$2.7 billion
Aqua America (NYSE: WTR)	13	53%	$2.4 billion
Applied Materials	12	94%	$15.1 billion
Humana	12	85%	$5.2 billion
BioMarin Pharmaceuticals	11	129%	$1.4 billion
Juniper Networks (Nasdaq: JNPR)	11	114%	$12.1 billion
St. Jude (NYSE: STJ)	11	89%	$13.7 billion
Comcast (Nasdaq: CMCSA)	11	86%	$38.8 billion

Source: Capital IQ, a division of Standard & Poor's.
Includes domestic stocks trading on major exchanges. Analyst recommendations as of June 30, 2009; institutional ownership as of March 31, 2009.
*Approximate. Institutional ownership may exceed 100% because of short sales or a lag time in the reporting of institutional holdings.

So what general themes can we gather from this list?

1. For all the flak that we at The Motley Fool dish out to Wall Street for its susceptibility to deadly value traps, chronically unhinged earnings estimates, and proclivity to overvalue stocks, I was pleasantly surprised to see so many strong names on the list. Activision, St. Jude, and Comcast have competitive advantages from their brand, patents, and monopolies, respectively. NYSE Euronext (NYSE: NYX) recently announced it will be using Juniper's hardware to help it build the world's fastest trading network. Aqua America, Enterprise Products, and Applied Materials enjoy strong support from our 135,000-member CAPS investment community.
   
   
2. Six of Wall Street's 10 favorite stocks hail from the health-care and IT industries. Qualcomm and Amgen (Nasdaq: AMGN) also ranked very highly. We could read this as an informed endorsement that these industries will lead the recovery. Analysts could also be betting that these businesses will benefit from stimulus spending on broadband access, National Institutes of Health research, and subsidized health insurance. Alternatively, it could just mean that even during recessions, Wall Street can't help but get wrapped up in its enthusiasm for exciting growth industries.
   
   
3. Almost by definition, most of Wall Street's favorite stocks are widely followed, widely owned, large, prominent companies. Twenty-six analysts cover these stocks on average. All have heavy institutional ownership, and the majority are large caps valued at more than $10 billion.

While many of them could turn out to be great investments, do any of Wall Street's 10 favorite stocks have what it takes to be among the market's 10 best-performing stocks?

Let's find out
To answer that question, let's compare Wall Street's best buy list to the past decade's 10 best-performing stocks.

For each of the past four years, Tim Hanson, former microcap analyst at Motley Fool Hidden Gems, has published his findings on the market's best-performing stocks. Here is his most recent data:

Company	Return, 1999-2008	Jan. 1, 1999 Market Cap
Hansen Natural	4,801%	$53 million
Celgene	4,167%	$252 million
Quality Systems (Nasdaq: QSII)	4,002%	$26 million
Clean Harbors	3,953%	$16 million
Green Mountain Coffee Roasters	3,786%	$19 million
Deckers Outdoor	3,374%	$19 million
Almost Family	3,122%	$9 million
XTO Energy	2,992%	$343 million
Southwestern Energy	2,911%	$187 million
FTI Consulting	2,907%	$16 million

Source: Capital IQ, a division of Standard & Poor's.

What characteristics do the market's top 10 stocks have in common?

They certainly don't belong to a common industry -- Hansen makes natural fruit juices and energy drinks, Deckers sells Ugg boots and other footwear, Almost Family does home nursing, and Southwestern searches for natural gas. These are about as varied and as seemingly random a collection of companies as you could hope to find.

But the 10 best-performing stocks did share three special things in common before they made their incredible runs. They were:

1. Ignored
2. Obscure
3. Small

While many of the stocks on Wall Street's top 10 list may be excellent choices, none of them shares the three qualities that seem so crucial to stellar performance.

Stocks possessing these traits not only have more opportunities for growth, but they also attract less coverage from Wall Street -- meaning they're more likely to be mispriced. Ironically, these very qualities make it nearly impossible for any of the best-performing stocks to rank among Wall Street's favorites!

And as I've shown in a previous column, those attributes are especially attractive today, when so many stocks are cheap. According to data I compiled from Ibbotson Associates, a leading authority on investing research, small stocks outperformed large stocks over the past 13 recessions by an average of four percentage points annually!

Small is good
Wall Street's 10 favorite stocks may turn out to be great investments, but it's highly unlikely that any company that attracts so much attention will be one of the top 10 stocks of the next decade. If you want to buy the best returns the market has to offer, you have to be willing to look where others aren't.

You're Not Set for Life

Every so often, PBS reruns its superb documentary on the history of Bethlehem Steel. One of the most poignant lines comes from the wife of a Bethlehem Steel employee, who said, "Bethlehem Steel was a giant. You knew if you worked for a place like that, you were . . . set for life."

But Bethlehem Steel went bankrupt, and retirees who thought they were "set for life" found themselves out in the cold instead. As Lantz Metz, a historian with the National Canal Museum, pointed out, "The human tragedy [of Bethlehem Steel] is not so much the loss of jobs . . . The human tragedy is the many, many people who were dependent on benefits which they thought were guaranteed."

And it could happen again.

A cautionary tale
Over a century and a half of American history, Bethlehem Steel built the iron bones of our nation. But by the 1990s, Bethlehem's own bones had become frail. Wracked by debt and beset by foreign rivals, Bethlehem struggled to earn the profits needed to pay salaries to 11,500 workers and the pensions for 120,000 retirees and dependents.

In 2001, Bethlehem gave up and filed for bankruptcy. A year later, it transferred its pension obligations to the U.S. Pension Benefit Guaranty Corporation (PBGC).

In one fell swoop, Bethlehem's retirees -- people who had already fulfilled their side of the social contract -- were put at the mercy of the federal bureaucracy. The problem was that mercy isn't bureaucracy's strong suit.

The PBGC reneged on Bethlehem's agreement to let workers retire on full pensions after 30 years. When the PBGC took over, the 30-years-and-out agreement was scrapped, and workers got the standard deal: Retirement at age 62, period. Even if you were only a week away from your 30th anniversary, if you hadn't crossed the finish line, the PBGC erased it under your nose.

Nor were retirees any safer. You see, when pensions are underfunded, the PBGC doesn't always make up the difference. In Bethlehem's case, the PBGC determined that the pension fund needed a cash infusion of $4.3 billion. The PBGC made up much of the difference.

Unfortunately, Bethlehem's employees and retirees had also bargained -- and worked -- for the promise of health-care coverage in retirement. The PBGC calculated the value of that promise at $3.1 billion -- but didn't cover a dime of it.

"It could happen to you"
Heed the prophetic words of Ed McMahon. A recent study conducted by Merrill Lynch listed 40 U.S. companies with significantly underfunded pension obligations. As you might expect, the list includes smokestack industrialists such as Dow (NYSE: DOW), Alcoa (NYSE: AA) and U.S. Steel (NYSE: X). As of December 31, 2008, the three firms' unfunded pension liabilities totaled $8.2 billion.

More surprising are the representatives of industries you might not expect to be in this situation: massively profitable biotech shops like Johnson & Johnson (NYSE: JNJ) and Pfizer (NYSE: PFE), for example, as well as black-gold rollers-in ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX).

What all these companies have in common is that they date from the era of the old social contract: You give your employer the best years of your life, and in return for your loyalty, and for taking a lower wage than you could have earned elsewhere, your employer will provide you a decent pension in your golden years.

It's time to master your money
Now every story needs a moral, and this one is no exception: The age of the old social contract is kaput.

Whether by design or incompetence, the managements of many of America's greatest companies of yesteryear are today unable to keep their word. As Steve Miller, the man brought in to "save" Bethlehem Steel in 2001, put it: "We do not have the money to make good on all the promises made by this corporation over the last 50 years."

If you're nearing retirement, or if you've already retired and depend on your former employer to keep paying your benefits, it's time to ask yourself how much faith you have in management.

Are you certain that your employer actually has the money to honor its promises? If you're not certain, then you need to do something about that. Because the sad truth is, there's only one person who can make your retirement secure for yourself and your family: You.

But here's the good news: You're not alone. At Motley Fool Rule Your Retirement, our sole goal is to help you be sure that when you're ready to retire, you're able to enjoy it. Take a free trial of the service now -- absolutely free. If you're not 100% thrilled with the service, we'll give you 30 days to cancel with no questions asked, no strings attached. Just click here to get started.

Which Sectors Are Attractive Right Now?

Wednesday evening marked the unofficial kick-off to earnings season, as Alcoa (NYSE: AA) reported its second-quarter results. While the aluminum producer gave the season a positive send-off (or "less negative," if we're frank), I'm not sure investors will find much cause for celebration as the results come in.

According to an estimate from Standard & Poor's, as reported earnings for the S&P 500 for the second quarter will fall by half year on year, so expectations are already set pretty low. Even so, the market has been grasping at "green straws" of positive economic data, going on a 30.5% run since the March 9 low. Optimism appears to have run its course for now as investors wait for hard earnings data to validate their hopes.

Where does the market stand right now?
Unfortunately, I think these green straws will prove to be either a statistical mirage or a bounce along the path of what will otherwise be a very weak and protracted recovery. If this is the case, how exposed are investors? Let's look at the market's valuation for a clue.

At yesterday's close of 879.56, the S&P 500 is trading just over 15 times average inflation-adjusted earnings for the past ten years. By historical standards, that is slightly cheap -- the average going back to 1881 is 16.3.

However, bear in mind that we are entering a period in which normal growth in the economy is below the historical trend, as the American consumer scales back on purchases in order to repair his/her balance sheet. This will have a knock-on effect, lowering corporate profit growth, which justifies a lower multiple. With that said, I think we should consider that the market is no better than fairly valued. Owning stocks right now isn't a problem -- if one can adopt the appropriate time horizon (7-10 years, no less).

Are there pockets of opportunity and/ or safety?
The two sectors that exhibit the greatest earnings uncertainty, measured by the ratio between the high EPS estimate and the low EPS estimate for 2009 are far and away financials (429%) and materials (312%), followed by energy (179%) and consumer discretionary (184%) in a virtual tie for third place.

All other things equal, earnings uncertainty creates opportunity for investors that have a longer time horizon than most institutional investors (6-12 months). However, patient capital is ineffective unless it is driven by value. In that respect, energy and financials look more attractive than materials and consumer discretionary (as the following table shows).

Energy and financials may not be undervalued as a whole, but they look like rich hunting grounds for experienced stock pickers -- investors with the time and ability to analyze individual names.

(I realize that consumer discretionary is actually cheaper on the basis of its P/E than financials -- I'll come back to why I'm not giving the nod to the former later on.)

	2009e EPS*	P/E	Return Since March 9th Market Low
S&P 500	$57.53	15.3	30.5%
Energy	$22.64	15.5	13.1%
Materials	$ 4.74	30.9	34.7%
Industrials	$13.46	13.4	35.8%
Consumer Discretionary	$ 8.82	19.8	38.6%
Consumer Staples	$17.32	13.8	19.4%
Health Care	$26.13	11.5	18.4%
Financials	$ 7.35	20.6	80.6%
Information Technology	$15.70	17.6	38.5%
Telecoms Services	$7.55	13.0	11.2%
Utilities	$11.71	11.7	20.8%

*This is a bottom-up estimate derived from the estimates for the index components.
Sources: Index values, Author's calculations, based on data from Capital IQ and Standard & Poor's.

If you're looking for some specific names, I ran a screen for "safe" stocks in these sectors, inverting the criteria of GMO strategist James Montier's screen for stocks that could cause permanent losses. The resulting stocks are priced at less than 16 times cyclically-adjusted earnings and don't appear to exhibit significant bankruptcy or earnings risk. Here are three of the names that came up:

Company	P/E (2009e earnings)	Cyclically-Adjusted P/E Ratio*
National Oilwell Varco (NYSE: NOV)	8.6	8.3
Moody's	17.3	11.0
ConocoPhillips (NYSE: COP)	11.9	8.9

*Price divided by average earnings-per-share over the prior 10 years. Note that this P/E differs from the one cited for the S&P 500 below; the latter uses inflation-adjusted earnings.

Lower-risk sectors
At the other end of the spectrum in terms of earnings uncertainty, are consumer staples and health care. These sectors also look appealing right now, particularly for investors with less appetite for risk. They are defensive sectors, of course -- but that's not all.

Consumer staples and health care were left behind by most sectors in the stock market rally from the March 9 low (see table above). That trend looks set to reverse, as they appear reasonably priced; I expect investors to warm to them as the market comes to terms with an anemic economy recovery (I don't think such a recovery has been fully factored into stock prices yet).

The following table contains four names that were produced by the same screen I referred to earlier and may be worth further scrutiny:

Company	P/E (2009e earnings)	Cyclically-Adjusted P/E Ratio*
Wal-Mart Stores (NYSE: WMT)	13.6	15.3
Walgreen (NYSE: WAG)	14.1	14.2
Zimmer Holdings (NYSE: ZMH)	10.2	11.3
Bristol-Myers Squibb (NYSE: BMY)	10.2	13.9

*Price divided by average earnings-per-share over the prior 10 years. Note that this P/E differs from the one cited for the S&P 500 below in that it is based on nominal earnings, while the latter uses inflation-adjusted earnings.

And one sector worth avoiding
Now that I've highlighted four sectors that I think are relatively attractive, I'll leave you with a warning regarding one that I find distinctly unattractive: consumer discretionary. At nearly 20 times estimated 2009 earnings, it looks pricey at a time when discretionary item purchases are much harder for consumers to justify (to themselves and/or their bankers). As investors come to terms with an economic environment that is permanently different ("permanently" insofar as stock valuations are concerned, in any case) than the one they have known until recently, that valuation may not hold up. Happy hunting!

5 Stocks Geared for Growth

A stock's price follows its earnings, which in turn follow its sales. A company needs only to take care of its business for investors to profit in the long run.

With that in mind, examining companies whose revenues and profits are rising -- and that inspire analysts' confidence in continued growth -- should give us a fertile group of solid candidates for long-term outperformance.

The roaring 20s
Below are a handful of companies that have enjoyed 20% or more annual growth in sales and earnings over the past three years, and for which analysts forecast total growth of 20% or more over the next two years. We'll then pair up those predictions with the research at Motley Fool CAPS to learn which companies the 135,000-plus members think have the best chances of beating the market over the long haul.

Company	3-Year Past Revenue Annual Growth	3-Year Past EPS Annual Growth	Estimated 2-Year EPS Growth	Estimated 2-Year Revenue Growth	CAPS Rating
Apple (Nasdaq: AAPL)	24.9%	41.1%	20.4%	28.2%	***
LHC Group (Nasdaq: LHCG)	37.4%	40.9%	38.7%	49.7%	***
NCI (Nasdaq: NCIT)	28.4%	33%	37.3%	27.9%	****
Open Text (Nasdaq: OTEX)	23.7%	200.1%	36%	21.1%	**
RRSat Global Communications Network (Nasdaq: RRST)	35.4%	27.9%	24%	41.8%	*****

Sources: Capital IQ (a division of Standard & Poor's) and Motley Fool CAPS.

Just because an analyst predicts that a company has fantastic growth opportunities doesn't mean those predictions will become reality. But analysts' preferred picks do offer an excellent starting place for your own research into extreme buying opportunities, so let's see why some of these companies may or may not be held in high esteem by investors, considering they appear to be churning out the sales and profits.

Tippling at the speakeasy
Despite being an important player in enterprise content management (ECM), Open Text still has to contend with some pretty big dogs in the form of IBM (NYSE: IBM) and EMC (NYSE: EMC). It has also grown through acquisitions, so it had to be spot-on with the deals it made. More than one-third of its total assets are wrapped up in goodwill -- a potential source of losses if it has to begin writing that down. So far, it hasn't had to, suggesting Open Text hasn't overpaid for its purchases. But it's a potential risk that, when added to a valuation of 29 times earnings, might keep it from ranking higher with investors.

Open Text's customers need to keep track of enterprise content in case of lawsuits or for compliance with regulations, among other things. Fortunately, this keeps them seeking out its solutions. Then there's a partnership with Microsoft that gives it continuing opportunities for growth. Open Text has grown to become the No. 2 ECM provider, and CAPS member 88X88 likes what it has been doing.

Excellent products in a real growth area for software. They've been buying up much of the smaller competition to improve products and market share.

RRSat Global is a different kind of content manager in that it provides distribution services to the TV and radio broadcasting industries. It operates a lean, low-cost business by leasing -- rather than owning -- satellite and terrestrial fiber-optic transmission capacity, and because its teleports are based in Israel, it offers the unique advantage of transmitting via a single satellite connection to nearly anywhere in the world.

That helps explain why it has grown to more than 500 TV and radio channels covering more than 150 countries, and why polar opposites like Fox News and Al Jazeera use its services.

The stock price went into a freefall in May after company officials adjusted their expectations for revenue. However, CAPS member mopoff thinks the sell-off was ill-advised:

Very good growth rates in both the recent past and future estimates. Low P/E relative to industry. Significant insider ownership but low institutional ownership. Nice dividend. The stock price recently dropped by a third after the company announced on May 7, 2009 that it was lowering its Q3 '09 and 2009 annual revenue estimates by a tiny bit. This was an overreaction. RRSat is a solid company in a promising industry, and even its revised [earnings] estimates are significantly higher than last year.

Great Stocks the Market Fears

Nassim Nicholas Taleb's best-selling book The Black Swan is probably loaded with more good advice than any other single source available. Read the book a few times, and you'll have a better understanding of risk and uncertainty than the vast majority of fancy-pants financial experts.

One common theme from the book is focusing on the ability to separate the empirical from the emotional. Sifting out the noise from the numbers -- the significant developments from the total ballyhoo. It's one of the most important lessons to remember.

Especially in a market like this, where fear, uncertainty, and raw emotion are in the driver's seat. More investment opportunities are being created from market temper tantrums than we've seen since the Great Depression. The trick to finding great investments -- and the kind of behavior that's made investors like Warren Buffett madly successful -- lies in shoving aside emotional barricades and focusing on the empirical facts. It's anything but easy, but the results are rarely disappointing.

To find a few stocks whose empirical details far outweigh their emotional fears, I called on the wisdom of our 135,000-member-strong CAPS community. In my opinion, these three stocks have too much fear and too little fact baked into their current prices:

Company	1-Year Return	Recent Share Price	Forward P/E Ratio	TTM Return on Equity	CAPS Rating   (5 max)
ConocoPhillips (NYSE: COP)	(54%)	$40.31	6.5	(28.1%)	*****
Goldman Sachs (NYSE: GS)	(15%)	$143.21	10.0	4.3%	**
Waste Management (NYSE: WMI)	(25%)	$26.78	12.2	17.4%	*****

Source: Motley Fool CAPS, Google Finance, and Yahoo! Finance, as of July 9.

A closer look at Goldman Sachs
Goldman Sachs is in a funny position: It's by far the best company in by far the worst industry. It's as if LeBron James were suddenly drafted to a prison basketball team. Would he still be considered great? Maybe, but he'd be lumped in with competitors whom people want to throttle. Nonetheless, he'd probably look greater on a prison team, if only because he'd be spectacularly dominant.

And that's what Goldman is -- a phenomenal bank wrapped up in the hullabaloo of failed competitors.

Now, I've been decidedly pessimistic on banks for a while now. It's an easy stance to take these days, I'm aware. So what's different about Goldman that makes it a worthwhile investment?

There are two types of financial crises. One is a solvency crisis, or when your assets don't cover your liabilities. The other is a liquidity crisis, in which you're wholly solvent but lacking readily available cash.

Goldman was always in the second batch. While banks such as Citigroup (NYSE: C) and Bank of America (NYSE: BAC) had legitimate solvency concerns, Goldman was purely strangled by a liquidity crisis. And don't kid yourself -- it was a crisis. There was a time last fall when it looked like Goldman might meet a quick demise. This was because its business model relies on regularly turning over large amounts of short-term debt. When the short-term debt market got nuked, Goldman could have run out of cash (a liquidity crisis) in no time flat.

But those days are gone for one reason: Goldman -- along with Morgan Stanley (NYSE: MS) and American Express (NYSE: AXP) -- are now bank holding companies. As a bank holding company, Goldman can borrow from the Federal Reserve when it needs to, purging the prospect of another liquidity crisis. Goldman's position is further reinforced by noting that measures of liquidity strain are generally back to normal levels.

So Goldman isn't going to die. Wonderful. But how will it thrive? Here's how CAPS member Gmoney91 put it:

Goldman Sachs has many things going in its favor. First, it is in an industry where many of direct competitors have gone by the [wayside]. With little competition, Goldman can charge higher prices, while also gobbling up the business left by its former competitors' void.

It really is about that simple. That's why its recent earnings have been off the charts. Goldman has always been the top investment bank. Now it's the top investment bank, with considerably less competition. Even in a terrible economy, that's a wonderful position to occupy.

GM: This Stock Is Worthless

Here's a good one: What do Confederate dollars, Monopoly money, and the old equity of General Motors (OTC: GMGMQ.PK) have in common?

They're all worthless!
Really, folks, this is not a drill. Your old GM shares -- the ones stuffed under your mattress, the ones in your brokerage account, and the ones you're seeing quoted on Yahoo! Finance -- are truly worthless. Don't get caught up in the excitement that GM emerged from bankruptcy court today. The shares of old GM trading on the over-the-counter market have literally no claim on the assets or earnings of the newly reborn General Motors.

Again, this isn't a drill, fancy, or conjecture. Consider this press release from GM last week:

GM management has noticed the continuing high trading volume in GM's common stock at prices in excess of $1. GM management continues to remind investors of its strong belief that there will be no value for the common stockholders in the bankruptcy liquidation process, even under the most optimistic of scenarios. Stockholders of a company in chapter 11 generally receive value only if all claims of the company's secured and unsecured creditors are fully satisfied. In this case, GM management strongly believes all such claims will not be fully satisfied, leading to its conclusion that GM common stock will have no value. [Emphasis added.]

It doesn't get much more black and white than a company's own management telling you that its shares will soon be rendered worthless. In case you missed the above memo, though, consider the following comment now on GM's website:

General Motors Company (the "new GM") currently has no publicly traded securities. Please note that none of the publicly owned stocks or bonds issued by the former General Motors Corporation (now renamed "Motors Liquidation Company"), including its common stock formerly traded on the New York Stock Exchange under the ticker symbol "GM", are or will become securities of General Motors Company, which is an independent separate company.

That's to say, the shares of the old GM you might own have no relation whatsoever to the GM that just emerged from bankruptcy. They are completely separate corporate entities.

Sadly, it seems many, many folks missed this memo -- these old certificates are trading up 40%. Barring an incredible twist of fate, it is almost unfathomable that someone buying these stubs today will end up not losing their entire investment, let alone make a profit.

The endgame
If you're able to sell your shares of GM, I (clearly) would recommend doing so before you lose the chance. You're not hurting America, GM, or anyone else by selling. In fact, the only person who loses out if you dump your worthless shares is the person ill-informed enough to take them off your hands.

But what if you're dead-set on investing in the "new GM"? You'll have to invest in either Ford (NYSE: F), Toyota Motor (NYSE: TM), Honda Motor (NYSE: HMC), or Nissan Motor (Nasdaq: NSANY) to get your automaker fix for the time being, as the new GM likely won't go public until at least next year.

To reiterate ...
The new GM will be leaner and far more stable than its predecessor, but the shares currently trading under the GM banner are completely unrelated to that enterprise. This game of musical chairs is about to stop for traders of GM's old equity. Don't be the fool caught standing.  

You May Have This One Wrong -- Here's Why

If you're like me, you probably think you've got it pretty much figured out -- the stuff that matters, anyway. But just in case, I hope you'll take a moment and read on.

In June 2007, and again this time last year, I was shoved aboard a plane and dragged around the globe. The idea was to test my impressions of the world, its markets, and most importantly, its people. What I found made me a better investor and a better person.

Myth No. 1: Two wheels good …
For reasons you will soon find apparent, I'd like to focus today on China, a sprawling mini-continent home to more than 1.3 billion people. If you are like I was, you're probably thinking "Man, that's a lot of Wizard of Oz-era Schwinns and pointy straw hats." And you'd be right -- 10 years ago.

Now it's a lot of cars. Don't misunderstand: Even I knew that Shanghai and Beijing -- with its five-loop beltway -- would be a Jiffy Lube paradise. But if, for you, China's "smaller" second- and even third-tier cities conjured images of Chinatown circa the 1906 earthquake, you're in for a shock (more on the tier-two story in a moment).

In fact, in light of recent events, you can't help but wonder how much better off General Motors or Ford (NYSE: F) would be if they'd gotten hold of a bigger piece of this market. It physically pained me to discover that, beyond the occasional Ford Focus and Toyota Camry, Volkswagen has all but cornered China's second- and third-tier markets. Or so it appeared to one American on the street in Shenzhen.

Myth No. 2: Small towns are small
Again, I knew Shanghai and Beijing would be big. What I didn't know is that the "smaller" tier-two cities are big, too. That is, until I had the pleasure of visiting five of the 20 or so Chinese towns bigger than Chicago. All are vibrant, modern cities -- no doubt twice the size they were this time last year -- my favorite being Xi'an, with its uncanny city wall.

Xi'an is also where I put to rest myths No. 3 and No. 4. The first seems a little silly in retrospect. I mean, maybe it's not completely insane to presume that a city home to IBM (NYSE: IBM), Intel (Nasdaq: INTC), and Applied Materials (Nasdaq: AMAT), among other Western technology giants, would speak a little English -- the so-called international language of science. But it's not true, either.

In fact, despite an infatuation with things Western, I doubt China's burgeoning middle class ever will adopt English as a second or "business" language. I don't think they'll need to. Just as it's clear that China's top businesses won't always rely on exports and massive trade surpluses -- for instance, the three we'll discuss just below.

And now for a delicate point …
I mention my fourth observation cautiously -- having seen a tiny part of the country and knowing full well I may have this one wrong. But perhaps my biggest surprise was the apparent loyalty and buoyancy of the workers I encountered. I'm not sure what I expected, but these were not the ground-down, discouraged, and exploited laborers I'd read and heard so much about.

True, I visited a relative handful of Chinese companies. And some -- for example, travel agent Ctrip.com (Nasdaq: CTRP) -- are admittedly white-collar businesses. China Green Agriculture (NYSE: CGA), whose massive greenhouses we toured, is a relatively hands-on agri-science business, however. And our visit to China Fire & Security (Nasdaq: CFSG) included a tour of a full-scale factory, albeit a high-tech one.

To be sure, the living arrangements seem at odds with what we know here in the United States. Often, the workers, mostly young men and women from the countryside, live in dormitories on campus. But my impression is that they were happily employed, even happy to be there. They certainly are friendly -- and sure love their basketball.

Of this I have no doubt
Again, I know that human rights remains a challenge in China, and I have no illusion that all companies are as pleasant to work for as Ctrip, China Green Agriculture, and China Fire. Clearly, these three companies stand out among China's best. Which is a big part of why my colleague, global investing expert and Motley Fool Global Gains co-advisor Tim Hanson, named them his top picks from our 2008 and 2007 research trips to China, respectively.

It may also explain why one stock is up 100% and the other has already tripled in less than a year. Of this I have no doubt whatsoever: Disproving my No. 5 China myth -- my idiotic notion that Americans aren't welcome there -- was pure pleasure. Having visited no less than half a dozen of China's cities, I can assure you that nothing could be further from the truth.

The people I met across China are among the most gracious and friendly I've met outside of Iowa. And this from a guy who accepted more than one dinner invitation with the awkward confession that "I won't likely eat anything with a head on it." (I feel oddly homesick just writing this column.)

The best China idea out there
But this is an article about investing, after all. As I mentioned earlier, my colleague Tim Hanson and I returned from our research trips to China in 2007 and 2008 with actionable investment ideas that are now up 100% and more than 200%, respectively. That's what got me thinking about this column today.

Unfortunately, I couldn't make the research trip this year. But Tim landed in Shanghai a few days ago. He wasn't in Shanghai long; this year he and his team plan to spend most of their time traveling across China's rural heartland, visiting companies and searching for the next China Fire, China Green Agriculture, or other three-digit gainer. I have a suspicion he'll find it.

If you'd like to hear about Tim's No. 1 China stock for 2009, here's how to do it. Click the link below and sample Tim Hanson's global stock research for 30 days absolutely free. That way, you're automatically set up to receive his dispatches live from the road in China. You'll also be the first to hear about his top China stock for 2009.

I just received Tim's second dispatch and will be following along avidly over the next two weeks. Even without the stock ideas, reading the dispatches is a blast. If you're interested in joining along and being among the first to receive Tim Hanson's top China stock for 2009, simply click here now.