stock chartWhile the European debt crisis is leading investors to have less confidence in the economy, keep in mind that we have also had three consecutive quarters of GDP growth, inflation is at a 44 year low and many companies are building up huge cash balances that they will tap into later for future growth.

Besides that, there is $3 trillion in money market funds, job growth has continued for two consecutive months, we are enjoying near zero interest rates, earnings growth is, well, growing by leaps and bounds. In my book, the conditions for stocks are ideal.

One simple metric make for an optimistic investor: The price-earnings to growth ratio or PEG. This ratio, created by Peter Lynch, measures how fast a stock is rising relative to its growth prospects. The calculation divides a stock's price-earnings ratio by its projected annual earnings-per-share growth. If the result is less than 1, stocks are cheap; greater than one and they start to get pricey.

Today, the S&P 500 is cheap. Looking out to 2011 earnings growth, stocks currently trade at a PEG of 0.68. If stocks were trading at a PEG of 1, the S&P 500 would hit 1,587, 47% above its current level of 1,079, by my calculations.

So what should you do? Consider investments in even cheaper stocks, with PEGs below 0.68. Here are three:
  • Exxon Mobil (XOM). Trading at $60.65, a P/E of 13.8 and earnings forecast to grow 20.65% in 2011, it has a low PEG of 0.67
  • Peabody Energy (BTU). Trading at $36.71, a P/E of 22.8 and earnings forecast to grow 52.7% in 2011, it has a super-low PEG of 0.43
  • Potash Corp. (POT). Trading at $97.14, a P/E of 25.7 and earnings forecast to grow 40.6% in 2011, its PEG of 0.63 makes it cheap.

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