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Why are Blue Chips So Cheap?

Written By Brian Hicks

Posted August 3, 2010

High-quality stocks have been left behind in recent market run-ups.

Garbage stocks have soared as blue chips languished.

Why the imbalance?

A number of different forces are at play here…

First, all that “liquidity” sloshing around has to end up somewhere. A lot of it got funneled into speculative stocks.

Risky investments have also benefited from various bailouts over the past years. The homebuyer tax credit, TALF, TARP, and countless other acronyms benefited risk-takers.

Did Google or Procter and Gamble need or benefit from these bailouts? No.

Shifting U.S. demographics is another reason that blue chips have been left behind.

Retirees are selling blue chips and switching to bonds and more conservative investments, as Jeremy Grantham of GMO pointed out in his Q2 update (PDF):

… There are more new retirees per new worker than there used to be. Retirees are selling stocks to pay the bills and to buy more conservative fixed income investments. And what stocks are they selling? By the time they retire, they probably own blue chips, having sold down most of their speculative stocks in the decade before retirement.

Lastly, risk is on. With interest rates this low for this long, the Fed is basically forcing you to take on risk.

So lever up, gamble a little — buying CDs will gradually erase your money over time, so why not jump in the game?

Quality on sale

Blue chips have been cheap for years. Their lackluster returns make it even more tempting to chase risky investments.

But if you’re like me, and you believe that we’re not out of the woods yet, buying defensive blue chips makes sense.

Here are a few of my favorites:

exxon-logo 1) Exxon Mobil (NYSE: XOM) – Calling a $292 billion company “cheap” seems ridiculous on some levels. How much bigger can a company get? A lot bigger — as long as oil prices hold up. XOM’s estimated forward P/E is only 9… That leaves a lot of room for upside if oil prices stay around these levels.

And if oil does go up — as many expect it to — Exxon will do even better.

2) Johnson and Johnson (NYSE: JNJ) – A favorite of my colleague Steve Christ, JNJ is another left-behind stock. It sports a fat 3.6% dividend that just keeps getting bigger, as you can see from the chart of payouts below:


3) Google (NASDAQ:GOOG) – I’ve been pounding the table on this one for a while, and will continue to kick the horse until it stops neighing. The stock is dirt-cheap and growing revenue at 20% a year. With $26b in cash, it’s a buy.

Those are just three high-quality market laggards. There are dozens more out there. Their time will come, and you’ll want to own them when it does.

And if the market does crash, names like these will offer a hell of a lot more protection than those high-beta names that have been out-performing.

Adam Sharp
Analyst, Wealth Daily