The Ultimate Signal to Load Up on Stocks?

Granted, Lynch wasn't managing money during the sort of
mega-macroeconomic crisis we're facing today. Plus, Lynch was likely
being funny and hyperbolic -- surely giving some thought to macroeconomic events can be useful for investors. (Anyone thought about buying a bank stock lately?)

So when we read the other day that lipstick sales rose more than 4%
in 2008, we nodded our heads. Here it was again: the leading lipstick
indicator.

How lipstick explains the economy
Wait, the what?

The leading lipstick indicator is a scientific measure of the sale
of, well, lipstick. When times are tough, the theory goes, women will
purchase lipstick instead of buying new threads or splurging for a new
necklace. During the Great Depression, lipstick sales reportedly rose
25%!

The term was introduced by Estee Lauder Chairman Leonard Lauder, who created it with nothing more than years on the job and astute observation.

Of course, lipstick sales are a comically unreliable economic
indicator, and lipstick alone can't save Estee Lauder investors from a
downturn in consumer discretionary spending. The obvious absurdity of
judging the state of the U.S. economy by sales of this single product
should at least suggest that other market "indicators" that judge our
economy by a single metric are equally dubious.

New home sales?
New home starts? Jobless claims? Non-farm payroll numbers? Durable
goods reports? They all make for interesting morning segments on CNBC,
but they're unreliable, subject to revision, and not worth much without
loads and loads of context. That means they're nothing but obnoxious
noise to the ears of long-term-focused investors.

Turning to Buffett -- who else?
So imagine our surprise when we read a Fortune piece a few weeks back with the following headline: "Buffett's Metric Says It's Time to Buy."

Would Warren Buffett -- the patron saint of fundamental-focused
value investing -- really suggest that broad-market indicators are
relevant to a buy decision?

As it turns out, they can be.

Buffett's signal looks at total stock market value compared to gross
domestic product. In 2001, when the percentage was greater than 130%,
Buffett said that "if the percentage falls to the 70% or 80% area,
buying stocks is likely to work very well for you."

At the end of January, Fortune reported, the ratio was at 75%.

The ultimate signal to load up on stocks?
Not so fast. This is, after all, the same Warren Buffett who told Berkshire Hathaway shareholders that "We try to price, rather than time, purchases." He went on to say:

In our view, it is folly to forgo buying shares in
an outstanding business whose long-term future is predictable, because
of short-term worries about an economy or a stock market that we know
to be unpredictable. Why scrap an informed decision because of an
uninformed guess? … We have usually made our best purchases when
apprehensions about some macro event were at a peak. Fear is the foe of
the faddist, but the friend of the fundamentalist.

In other words, it's small-f foolish to abstain from buying because
stocks in general appear "overheated," just as it's unwise to buy
willy-nilly because stocks appear "cheap." Investing the Buffett way
(hey, it's worked out pretty well for him) is about bottom-up
fundamental analysis, with a focus on long-term competitive advantages.

Which brings us to an analogy
But
look, it'd be daft to ignore the fact that it's better to go fishing at
some times of the day than others, and that that optimal time of day is
determined by the weather and moon. If you go out at the wrong time
with the best bait, your chances of hooking a fish are diminished; if
you go out at the right time with nothing more than hook and a string,
your chances are improved.

Similarly, in investing, you're more
likely to earn great returns if you buy when stocks across the board
are cheap, than if you try to find the one or two bargains at a time
when stocks across the board are expensive. And that's why some macroeconomic analysis can be useful: It tells you the best times to go fishing.

Today
is one of those times. As we mentioned earlier, the market recently
broadly traded for just 75% of GDP. While it's rebounded a bit since
the beginning of April, on an individual level, many impressive
companies are trading at enormous discounts relative to their norms:

Data from Morningstar.

So I should buy those six stocks?

Nope.
This list doesn't mean that all of these stocks will beat the market
from here on out. But it does mean that now is a great time to go
fishing for top stocks in your portfolio. If you're looking for some
help doing just that, you can get the latest guidance and buy and sell
recommendations from Fool co-founders David and Tom Gardner at Motley Fool Stock Advisor.

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This article was first published April 20, 2009. It has been updated.

Brian Richards
owns shares of Microsoft. Tim Hanson owns shares of Berkshire Hathaway. Berkshire and eBay are Motley Fool Stock Advisor and Inside Value recommendations. Microsoft is also an Inside Value pick. The Fool owns shares of Berkshire Hathaway. The Fool's disclosure policysays
that if you're looking for fishing advice, try arkansasstripers.com --
but be careful when typing in the URL. It learned the hard way after an
awkward talk with our IT department

© 2009 UCLICK L.L.C.