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    Is it too late to get back into stocks? Not by most measures

    These days, big US companies get nearly half their revenue overseas, so investors need to worry about other economies, too.
    Alastair Grant/Associated Press/File 2013
    These days, big US companies get nearly half their revenue overseas, so investors need to worry about other economies, too.

    NEW YORK — Is it too late? If you’ve stayed out of stocks recently, you might be worried that you’ve missed your chance to get back in. After all, they must be expensive now that the Dow Jones industrial average has risen 120 percent in four years to a record high.

    The good news is that stocks still seem a good bet, despite the run-up. The bad news: They’re no bargain, at least by some measures.

    Many investors obsess about stock prices. But you must give equal weight to a company’s earnings. When earnings rise, stocks become more valuable — and their prices usually rise, too.


    That seems to be happening now.

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    ‘‘We’ve had record profits upon record profits,’’ says John Butters, senior earnings analyst at FactSet, a research firm. ‘‘And estimates are we’ll have record profits this year, too.’’

    What’s more, some of the typical threats — such as rising inflation and interest rates, which often trigger a recession — seem unlikely to appear soon. Among reasons to consider stocks:

    A stronger economy

    There are no signs of a recession. And that’s encouraging for stocks, which almost always fall ahead of an economic downturn. Stocks started falling two months before the Great Recession began in December 2007 and one year before the recession that started in March 2001.

    Better yet, the economy may be on the verge of faster growth. The Labor Department said Friday that the unemployment rate in February declined from 7.9 percent to 7.7 percent, its lowest since December 2008. More jobs means more money for people to spend, and consumer spending drives 70 percent of economic activity.


    And there has been a flurry of other hopeful signs lately. Home builders broke ground on new homes last year at the fastest pace in four years. Sales of autos are at a five-year high.

    If recent history is any guide, this economic expansion is still young. The expansion that began in June 2009 is 44 months old. The previous three expansions lasted 73 months, 120 months, and 92 months. Corporate earnings grow in expansions, which can push stocks higher.

    In the 1982-1990 expansion, earnings of companies in the Standard and Poor’s 500 stock index grew 50 percent, according to S&P Dow Jones Indices, which oversees the index. The S&P 500 itself surged nearly 170 percent.

    For 2013, earnings of S&P 500 companies are expected to grow 7.9 percent, then another 11.5 percent next year, FactSet says. So stocks could rise fast. But history offers three caveats:

     First, if you look at the 11 expansions back to World War II, instead of the last three, they last 59 months, on average. By that measure, the current expansion is middle-aged, not young.


     Second, investing based on US economic expansions may not work as well as in the past. Big US companies generate nearly half their revenue from overseas now, so you need to worry about other economies, too. The 17 European countries that use the euro as a currency have been in recession for more than a year. Japan, the world’s third-largest economy, has struggled to grow.

    If the worst is over for these countries, US stocks could continue rising. If the growth drags, stocks could fall.

     Third, earnings forecasts are often too high. They come from financial analysts who study companies and advise on stocks to buy. In the past 15 years, their annual earnings forecasts were an average of 10 percent too high, according to FactSet. Last year, they got closer: They overestimated by 4 percent.

    Reasonably priced stocks

    Investors like to use a gauge called price-earnings ratios in deciding whether to buy or sell. Low P/E ratios signal that stocks are cheap relative to a company’s earnings; high ones signal they are expensive.

    Right now the ratios are neither low nor high, suggesting stocks are reasonably priced.

    To calculate a P/E, you divide the price of a stock by its annual earnings per share. A company that earns $4 a share and has a $60 stock has a P/E of 15. Most investors calculate P/E’s two ways: based on estimates of earnings the next 12 months and on earnings the past 12.

    Stocks in the S&P 500 are at 13.7 times estimated earnings per share in 2013. That is close to the average estimated P/E ratio of 14.2 over the past 10 years, according to FactSet. The P/E based on past earnings paints a similar picture. The S&P 500 trades now at 17.6 times earnings per share in 2012, basically the same as the 17.5 average since World War II, according to S&P Dow Jones Indices.

    Again, a caveat. Another way to calculate P/E’s, called a ‘‘cyclically adjusted’’ ratio, suggests stocks are not such a decent deal. Its champion is economist Robert Shiller of Yale University, who warned about the dot-com and housing bubbles. He thinks it’s misleading to look at just one year because earnings can surge or drop with the economic cycle. To smooth such distortions, he looks at annual earnings per share averaged over the prior 10 years.

    The cyclically adjusted ratio is 23 times. Since World War II, it’s ranged between 6.6 and 44.2, and the average is 18.3. That suggests stocks are expensive, though perhaps not wildly so.

    Optimistic investors

    A new love of stocks could prove a powerful force pushing prices up. In fact, it can push them up even if earnings don’t increase.

    That’s what happened in the five years through 1986. Earnings fell 2 percent, but the S&P 500 almost doubled as small investors who had soured on stocks in the 1970s returned to the market. The multiple — shorthand for the price-earnings ratio — rose from eight to nearly 17.

    Market watchers refer to this as ‘‘multiple expansion.’’ Will it happen again?

    As stocks have surged over the past four years, individual investors have been selling, which is nearly unprecedented in a bull market. But they may be having second thoughts. In January, they put nearly $20 billion more into US stock mutual funds than they took out, according to the Investment Company Institute, a trade group for funds.

    Some financial analysts say we are at the start of a ‘‘Great Rotation’’ of investors shifting money into stocks from bonds. If that happens, stocks could soar.

    Howard Silverblatt, at S&P Dow Jones, thinks investors are too worried about the euro and government spending cuts to dive into stocks.

    ‘‘We don’t have a lot of confidence going forward so people are limiting what they’re willing to wager,’’ he says.

    Low interest rates

    Interest rates are near record lows. That’s good for stocks because it lowers borrowing costs for companies and makes bonds, which compete with stocks for investor money, less appealing.

    If you want to kill a stock rally, then raise interest rates. That’s what happened in the run-up to Black Monday, Oct. 19, 1987. The yield on the 30-year Treasury bond rose above 10 percent. Investors thought, ‘‘If I could make 10 percent each year for 30 years in bonds, why keep my money in stocks?’’ So they sold and stocks drifted lower. Then Black Monday struck. The Dow plunged 508 points, or nearly 23 percent — its largest fall in a single day. Today, the yield on the 10-year Treasury is 2.05 percent, less than half its 20-year average of 4.7 percent. Of course, interest rates could jump on fears of higher inflation. But the Fed has promised to keep the benchmark rate it controls near zero until unemployment falls to 6.5 percent. Unemployment today is 7.7 percent.