3 stocks to profit from the coming sharemarket rally

Investors buying shares at today's prices potentially stand to benefit twice. Firstly, from rising profits, and secondly, from a removal of the pessimism discount. Here are 3 shares set to benefit.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

I wrote recently about the market rally I believe is on the way. I didn't (and can't) predict its timing, but I am very sure that patient investors will benefit when it comes.

My premise is that the market is currently undervaluing Australia's listed companies, based on a near-sighted extrapolation of the recent past and an under-appreciation of the longer term.

I believe the future for many Australian companies will be brighter than the market is suggesting. In addition, price earnings multiples have become infected with a 'pessimism discount' – the market is paying a lower price for the same dollar of earnings than it has been prepared to in the past – largely due to the level of uncertainty that investors are currently feeling.

Two chances to win
If the theory holds – and my money (metaphorically and literally) says it will – then the logical conclusion is that the market is undervaluing the earnings power of some of Australia's best businesses, and is currently offering that earnings power to us at a bargain price.

The upside of this situation is that investors buying wisely at today's prices potentially stand to benefit twice.

Firstly, as corporate profits improve, share prices will improve with them. It stands to reason that a company earning $100 in profits this year will be worth more if it earns $120 next year.

Secondly, investors will benefit as the market slowly removes the 'pessimism discount' that is currently depressing share prices. As the market starts to move out of its current funk and feels more certain about the future, other investors will be prepared to pay more for the same level of earnings compared to the multiple they were comfortable paying when they felt more concerned.

Look past tomorrow
The recipe for taking advantage of such a situation would be to find a company whose current or immediate future earnings are lower than they are likely to be further down the road, and whose share price (expressed as a multiple of those earnings) is unusually low.

In that situation, as profit returns to more normal levels and the market recovers its nerve, today's enterprising investor will reap the returns.

There are no guarantees in life – it's possible that the downturn ends up being longer in duration, or that the company is weaker (financially or competitively) that was first thought.  Quality always wins and it pays to be picky.

There are some quality businesses on the ASX trading at pessimistically low prices – and multiples – and for whom the market is implying a less than rosy future.

Fallen angels waiting to fly
One such business – depending on your world view – is David Jones (ASX: DJS). The upmarket department store retailer was sold off heavily among investor concerns that consumer spending has fallen and was migrating online. As a result, DJs is down almost 40% from its previous highs, and is trading on a trailing price earnings ratio of less than 10 times earnings. Even if the multiple doesn't grow, DJs would have to do pretty badly to be a bad investment from here.

Salmat (ASX: SLM), the junk-mail and call-centre king, delivered a disappointing profit result in the most recent financial year, amid a lost call-centre contract and reductions in retailer advertising budgets. Investors punished the company, with the share price halving from its 12-month high before recovering slightly. Trading at only 12 times historical earnings, and probably less than 10 times the current year's expected profit, there's plenty of pessimism already reflected in the share price.

Australia's self-described 'third force' in groceries is Metcash (ASX: MTS). While Woolworths (ASX: WOW) and Wesfarmers' (ASX: WES) Coles grab all the headlines, Metcash has done a great job of consolidating and growing the rest of the retail grocery sector. The company is also strong in alcohol wholesaling, and has recently bought a majority stake in hardware retailer Mitre 10. While consumer confidence might be fragile, we all still need groceries. Despite a growing bottom line, Metcash's share price is off its 52-week highs, and is trading at a trailing P/E of under 13 times.

Foolish take-away
If you've ever tried to buy an umbrella when it's raining outside, you'll know they're scarce and expensive. When the sun is shining, umbrellas are often going cheap.

Likewise, an investor who waits for certainty is likely to pay a high price for that confidence – and experience suggests that by that point, the next downturn is probably closer than most people think. Just ask those who bought tech shares in 1999 or Americans who refinanced their houses in 2007.

The best time to buy quality, well managed companies with sustainable competitive advantages is when no-one else is – that's when the shares are on sale. When confidence returns and the rally comes, those are the businesses you'll be glad you bought on the cheap.

Are you looking for more quality stock ideas? Readers need look no further than The Motley Fool's Top Stock For 2012. Click here now to request this special report, whilst it's still free and available.

Scott Phillips is The Motley Fool's feature columnist. Scott owns shares in David Jones and Woolworths. The Motley Fool has a disclosure policy. This article authorised by Bruce Jackson.

More on ⏸️ Best ASX Shares

Three travellers laughing and smiling outside an airport
⏸️ Best ASX Shares

If you'd invested $2,000 in Webjet (ASX:WEB) shares 10 years ago, here's what it would be worth now

The travel expert has proved a winner for long-haul investors...

Read more »

illustration of three houses with one under a magnifying glass signifying mcgrath share price on watch
⏸️ Best ASX Shares

The 5 best ASX real estate shares of the 2021 financial year unmasked

Office space, industrial storage, retail malls and residential. These companies cover them all.

Read more »

asx share price increase represented by golden dollar sign rocketing out from white domes of lithium
Energy Shares

5 best ASX energy shares of the 2021 financial year revealed

As the world emerged from initial COVID lockdowns, the demand for energy soared.

Read more »

best asx 200 shares of financial year 2021 represented by 2021 formed with gold piggy bank
⏸️ Best ASX Shares

Meet the best performing ASX 200 shares of FY21. Are yours on the list?

These companies have been crowned the best of the best in FY21...

Read more »

retail asx share price represented by shopping trolley full of cash
⏸️ Best ASX Shares

How I'd build a 'best stocks to buy now' list

Focusing on the quality and prices of companies from a diverse range of sectors could make it easier to build…

Read more »

asx share price on watch represented by investor looking through magnifying glass
⏸️ Best ASX Shares

How I'd aim to find top shares to buy in March 2021

Comparing companies with their peers and considering how they might change in future could allow an investor to find the…

Read more »

Brest ASX shares represented by piggy bank surrounded by autumn leaves
⏸️ Best ASX Shares

Top ASX shares to buy in March 2021

Our Foolish contributors have compiled a list of some of the ASX shares experts are saying to Buy in March.…

Read more »

rising asx share price represented by man with arms raised against blackboard featuring images of dollar notes
⏸️ Best ASX Shares

Why the Wesfarmers (ASX:WES) share price has soared 24% in a year

The Wesfarmers Ltd (ASX:WES) share price has been a solid performer over the past year. Here's why this ASX blue…

Read more »