Quarterly Investment Guide

Dow hits 20,000, but there are still deals for value investors

Bryan Borzykowski, special to CNBC.com
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Now that the Dow Jones Industrial Average hit an all-time high of 20,000 on Wednesday, investors may be wondering if equities are getting too expensive to own. Indeed, the DJIA's current price-to-earnings ratio is 20.6, up from 15.7 a year ago, and it's trading at about 16.3 times forward earnings. But take a closer look at the market and how Trump's pro-growth policies could impact future earnings, and stocks don't look nearly as expensive as one might think.

Charles Lemonides, founder of ValueWorks, a New York-based investment management firm, has built his business on buying undervalued stocks, but he's not worried. In fact, he's encouraged by the Dow's breakthrough, especially after the lackluster year we've had. "It's about time we resumed a market advance," he says.

With about 200,000 jobs being added a month and still solid economic growth, he says that markets should be moving higher. He also thinks we'll see many more records being broken next year and into 2018 as growth continues.

But Lemonides says he is not concerned that valuations will get out of hand. In fact, market ratios could fall as energy companies start to rebound on better oil prices, he says. Energy stock prices have come back up this year, but earnings haven't yet climbed, and if earnings don't rise, then PE ratios appear high. According to Bloomberg, the S&P 500 Energy Index is currently trading at 137 times earnings.

"The energy space has contributed very little to the earnings side of PE, because of the collapse in commodity prices," Lemonides says. "That hole in earnings power will get filled over the next 12 months as energy prices stabilize."

Valuations will also start looking more attractive if Trump's pro-growth agenda gets put into place. Corporate tax cuts, specifically, could cause earnings to jump, says Michael Thompson, managing director of S&P Investment Advisory Services.

We could see 17 percent earnings growth over the next few years, he says, compared to a 7 percent historical norm. In that situation, valuations don't look nearly as expensive.

Dow 20k a difficult target but we'll get there: Expert

He also thinks stocks will continue to rise, even with interest rates rising by 0.25 percent. Thompson's expecting to see 2 percent dividend growth and about 5 percent to 7 percent capital gains over the next 12 months.

With all that in mind, equities still look attractive to Lemonides. Many high-quality blue-chip operations, in energy pipelines, technology and biotech, among other sectors, are still trading at historically low valuations.

Cisco, for instance, is trading at about 13 times next year's earnings, American Express is trading at about 14 times, and biotech company Gilead Sciences is trading at about 7 times earnings. Pipeline company Williams Partners is also attractive, he says. Lemonides owns, and has been purchasing, shares in all these companies this year.

The opportunities are obvious, and they're right in front of you.
Charles Lemonides
founder of ValueWorks

Part of the reason why valuations aren't higher is that while the Dow and the S&P 500 have been making headlines, investors still have a lot of money in bonds and in cash, says Lemonides. Many people think that because the market keeps rising, it could fall at any time, so they've been cautious, he says.

Some companies have done well — consumer staples, dividend-paying equities and materials either look or have looked expensive recently — but there's more to the market than these sectors.

If anything, Lemonides is looking forward to more record-breaking performances, because the undervalued stocks that he's buying now will, he hopes, move higher over the next couple of years. And those who think that markets are overvalued aren't paying close enough attention, he says.

"Those who say these are not attractively valued stocks don't understand the market," he says. "The opportunities are obvious, and they're right in front of you. You're looking at high-quality companies whose share prices have been mediocre for extended periods of time. And it runs the gamut."

— By Bryan Borzykowski, special to CNBC.com

(Update: This story has been updated to reflect the Dow opening above 20,000 on Wednesday, Jan. 25.)