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The U.S. market has had a disappointing decade, but investors shouldn't give up on international diversification

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With the stock market posting its best week in a month, it's remarkable to see a Dow stock trading at a forward price-to-earnings ratio of less than 10, but eight of 30 are beneath that level. They're not only undervalued on a historical basis, but also based on 2011 earnings expectations. With last week's rally suggesting the recovery is picking up, investors ought to consider these blue-chip stocks. They are ordered from cheap to cheapest.



8. Merck & Co. Inc. sells pharmaceuticals including Nasonex, Pepcid and Crixivan.

Quarter: Merck's third-quarter net income tumbled 90 per cent to $342-million and earnings per share fell 93 per cent to 11 cents, hurt by a higher share count. However, excluding one-time items, earnings decreased a modest 6 per cent to 85 cents. Revenue surged 94 per cent. The gross margin rose from 83 per cent to 91 per cent, but the operating margin stagnated at 30 per cent. Merck held $11-billion of cash and $18-billion of debt at quarter's end, equal to a quick ratio of 1 and a debt-to-equity ratio of 0.3.

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Valuation: Merck's stock sells for a forward earnings multiple of 9.2, a book value multiple of 1.9 and a sales multiple of 2.5, 21 per cent, 60 per cent and 22 per cent discounts to pharmaceutical industry averages. Its cash flow multiple of 12 is on par with its pharma peer average. Merck commands a trailing earnings multiple of 13, compared to a five-year average earnings multiple of 15. The stock has underperformed the Dow in 2010, falling 3.9 per cent as the broader index rose 9 per cent.

Dividend: Merck pays a quarterly dividend of 38 cents, equaling a yield of 4.3 per cent with a payout ratio of 54 per cent. It has paid a 38 cent dividend since 2004. Prior to 2004, Merck had a record of distribution increases.

7. JPMorgan Chase & Co. is a diversified financial company whose commercial bank serves 26,000 clients. It also has an investment banking unit.

Quarter: JPMorgan's third-quarter net income increased 23 per cent to $4.4-billion and earnings per share climbed 26 per cent to $1.01. Revenue dropped 11 per cent to $27-billion. The gross margin widened from 61 per cent to 77 per cent and the operating margin extended from 31 per cent to 44 per cent. JPMorgan held $290-billion of cash and equivalents at the end of the quarter and $660-billion of debt, converting to a debt-to-equity ratio of 3.8. It had a tier-one capital ratio of 9.5 per cent at quarter's end.

Valuation: JPMorgan's stock trades at a forward earnings multiple of 8.1 and a sales multiple of 1.3, 27 per cent and 24 per cent discounts to financial services industry averages. Its book value multiple, though ostensibly cheap at 0.9, is on par with the peer average. And its cash flow multiple of 29 reflects a 50 per cent premium. JPMorgan is selling for a trailing earnings multiple of 11, a 27 per cent peer discount and a 53 per cent discount to its five-year average multiple of nearly 23.

Dividend: JPMorgan pays a paltry quarterly dividend of five cents, translating to a 0.5 per cent annual yield with a 6 per cent payout ratio. It has paid a five cent dividend since 2009. Previously, it paid a distribution of up to 38 cents.

6. Travelers Co. is a diversified insurer.

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Quarter: Third-quarter net income ascended 7.5 per cent to $1-billion. Earnings per share advanced 28 per cent to $2.11. Revenue inched up 2.4 per cent to $6.5-billion. The gross margin expanded from 35 per cent to 36 per cent and the operating margin stretched from 21 per cent to 23 per cent. Travelers carries $5.3-billion of cash and equivalents and $6.3-billion of debt, equal to a debt-to-equity ratio of 0.3. Its subsidiaries receive top financial strength ratings, with grades of AA- from Standard & Poor's.

Valuation: Travelers' stock sells for a forward earnings multiple of 9.1, a book value multiple of 0.9, a sales multiple of 1 and a cash flow multiple of 7.3, 35 per cent, 76 per cent, 78 per cent and 51 per cent discounts to insurance industry averages. A trailing earnings multiple of 7.8 represents a 66 per cent discount to the peer average and a 16 per cent discount to Travelers' five-year average multiple of 9.3. The stock's PEG ratio, a measure of value relative to growth, of 0.9 signals a 10 per cent discount.

Dividend: Travelers pays a quarterly dividend of 36 cents, converting to an annual yield of 2.6 per cent with a payout ratio of 20 per cent. Travelers boosted its dividend from 33 cents in February. The company's board has a record of regular distribution increases.

5. Microsoft Corp. is a software company.

Quarter: Microsoft's fiscal first-quarter net income soared 51 per cent to $5.4-billion. Earnings per share surged 55 per cent to 62 cents. Revenue grew 25 per cent to $16-billion. The gross margin rose from 83 per cent to 85 per cent and the operating margin climbed from 35 per cent to 44 per cent. Microsoft held $44-billion of cash and $11-billion of debt at the end of the quarter, equal to a net cash position of nearly $34-billion. A quick ratio of 2.1 and a debt-to-equity ratio of 0.2 signal fiscal prudence.

Valuation: Microsoft's stock trades at a forward earnings multiple of 9.7, a sales multiple of 3.4 and a cash flow multiple of 8.5, 59 per cent, 74 per cent and 53 per cent discounts to software industry averages. However, its book value multiple of 4.8 is on par with peers'. A PEG ratio of 0.7 signals a 30 per cent discount to estimated long-run fair value. Microsoft's trailing earnings multiple of 11 represents a 69 per cent discount to its peer average and a 32 per cent discount to the stock's five-year average multiple.

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Dividend: Microsoft pays a quarterly dividend of 16 cents, equal to a yield of 2.4 per cent with a payout ratio of 24 per cent. It boosted the dividend from 33 cents in the latest quarter. It has a record of distribution increases.

4. Hewlett-Packard Co. sells computer hardware and servers as well as consulting services.

Quarter: Fiscal fourth-quarter net income ascended 5.2 per cent to $2.5-billion. Earnings per share increased 11 per cent to $1.10, helped by a smaller float. Revenue grew 8.1 per cent to $33-billion. The gross margin extended from 26 per cent to 27 per cent, but the operating margin hovered at 11 per cent. The balance sheet stored $11-billion of cash and $22-billion of debt at quarter's end, converting to quick ratio of 0.7 and a debt-to-equity ratio of 0.6. HP's 12-month sales have grown 10 per cent.

Valuation: HP's stock sells for a forward earnings multiple of 7.4, a book value multiple of 2.4, a sales multiple of 0.8 and a cash flow multiple of 8.2, 52 per cent, 49 per cent, 76 per cent and 38 per cent discounts to computers and peripherals industry averages. Its PEG ratio of 0.3 reflects a 70 per cent discount to estimated fair value. HP's trailing earnings multiple of 12 represents a 46 per cent discount to the industry average and a 23 per cent discount to the five-year average earnings multiple of 15.

Dividend: Hewlett-Packard pays a quarterly dividend of eight cents, converting to a one-year yield of 0.8 per cent with a payout ratio of just 9 per cent. The board has kept the quarterly dividend steady at eight cents since 1998.



3. Chevron Corp. is the world's second-largest energy company. Its rival is Exxon(XOM_).

Quarter: Third-quarter net income declined 1.7 per cent to $3.8-billion. Earnings per share fell 2.6 per cent to $1.87. Revenue increased 7.6 per cent to $46-billion. The gross margin extended from 21 per cent to 23 per cent and the operating margin expanded from 11 per cent to 12 per cent. Chevron held nearly $15-billion of cash and equivalents and $11-billion of debt at the end of the quarter, equaling a quick ratio of 1.2 and a debt-to-equity ratio of 0.1. Crude oil currently costs nearly $89 a barrel.

Valuation: Chevron's stock trades at a forward earnings multiple of 8.5, a book value multiple of 1.6, a sales multiple of 0.9 and a cash flow multiple of 5.5, 58 per cent, 59 per cent, 71 per cent and 34 per cent discounts to oil and gas peer averages. Its PEG ratio of 0.1 reflects a 90 per cent discount to estimated long-term fair value. Chevron's trailing earnings multiple of 9.9 represents a 46 per cent discount to the peer average, but a modest premium to the company's five-year average.

Dividend: Chevron pays a quarterly dividend of 72 cents, translating to a yield of 3.4 per cent, higher than the 10-year Treasury yield, and a payout ratio of 34 per cent. Chevron has a record of distribution increases.



2. Bank of America Corp. is a financial-services company. It's the top mortgage lender in the U.S.

Quarter: Bank of America's third-quarter loss widened to $7.3-billion, or 77 cents a share, hurt by a goodwill impairment charge in its credit card business due to a new regulatory rule. The company swung to an adjusted profit of $3.1-billion, or 27 cents, from a year-ago loss. Revenue fell 2 per cent. The gross margin jumped from 43 per cent to 66 per cent and the operating margin climbed from 11 per cent to 31 per cent. Bank of America has $840-billion of debt, equal to a debt-to-equity ratio of 3.6.

Valuation: Bank of America's stock sells for a forward earnings multiple of 7.6, a book value multiple of 0.5, a sales multiple of 0.8 and a cash flow multiple of 1, 32 per cent, 42 per cent, 51 per cent and 95 per cent discounts to diversified financial services industry averages. Bank of America is selling at a discount to its five-year average earnings multiple of 15 and its profit spreads consistently exceed peer averages. The company's shares have fallen 22 per cent in 2010 amid mortgage regulatory scrutiny.

Dividend: Bank of America pays a quarterly dividend of one cent, converting to a paltry yield of 0.3 per cent. Its dividend was cut from a high of 68 cents during the recession as the bank accepted federal TARP money.



1. Pfizer Inc. sells pharmaceuticals including Dimetapp, Dristan and Halcion.

Quarter: Pfizer's third-quarter net income plummeted 70 per cent to $866-million and earnings per share dropped 74 per cent to 11 cents. Revenue advanced 39 per cent to $16-billion. The gross margin declined from 88 per cent to 87 per cent and the operating margin fell from 38 per cent to 31 per cent. Pfizer has $22-billion of cash and $44-billion of debt, translating to a quick ratio of 1.6 and a debt-to-equity ratio of 0.5. Pfizer's 12-month sales have increased 46 per cent, though net profit has fallen 25 per cent.

Valuation: Pfizer's stock trades at a forward earnings multiple of 7.3, a book value multiple of 1.5 and a sales multiple of 2, 38 per cent, 68 per cent and 36 per cent discounts to pharmaceuticals industry averages. But, its cash flow multiple of 13 represents a premium of 18 per cent. A PEG ratio, calculated by dividing the P/E ratio by analysts' long-term growth forecast, of 0.3 demonstrates a 70 per cent discount to estimated fair value. Pfizer is a consensus buy-side value pick, but has fallen 8.5 per cent in 2010.

Dividend: Pfizer pays a quarterly dividend of 18 cents, translating to a one-year yield of 4.3 per cent and an elevated payout ratio of 94 per cent. Pfizer halved its dividend to 16 cents in 2009 amid recession, but has since lifted it.





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