5-Star Stocks in the Bargain Bin

Everyone loves a bargain. Be it at the grocery store, the local flea market, or at the neighborhood car dealership, people inherently understand the benefits of getting a great deal.

Yet, despite this infatuation with bargain opportunities, it doesn't occur to many investors that buying cheap stocks is possibly the best way to squeeze a whole lot of bang out of a hard-earned buck. As legendary investor Christopher H. Browne writes in The Little Book of Value Investing, we should always attempt to "buy stocks like steaks ... on sale."

Our penny-pinching process
So, with the help of our community over at Motley Fool CAPS, I'll once again try to find some cheap stocks for all of my stingy kindred spirits.

The approach is far from complicated: We'll run a simple screen for five-star stocks (the highest rating a stock can get in CAPS) that have enterprise value-to-EBITDA (EV/EBITDA) multiples below 10. We'll use EV/EBITDA rather than the more common price-to-earnings ratio, so that we can account for differences in each company's capital structure.

Dive in the bargain bin
By running this screen, we'll zero in on statistically cheap stocks that, according to our CAPS community, have plenty of great reasons to trade at much higher levels.

So without further ado, here's this week's bargain bin:

As usual, our list isn't exactly brimming with exciting, or even well-recognized, names. But that should be just fine with us. As sharp Fools know well, boring stories often translate into the market's biggest returns.

Tyco's tot
Thanks to Mr. Market's broad sell-off, it hasn't exactly been tough to find stocks for this column. After all, the best bargains are created when investors sell even good companies just to "get out" of the market completely. So when Covidien -- a stock that already faces indiscriminate selling pressure of another sort -- popped up on my screen this week, I decided to take a closer look. With 26 CAPS All-Stars bullish about its prospects (and just one lone bear), this might be an extra-special special situation.

For the uninitiated, Covidien is a diversified health-care company that was spun off from scandal-ridden conglomerate and Motley Fool Inside Value selection Tyco International (NYSE:TYC) last June. I'll touch on Covidien's business in a second, but it's worth noting that much of Covidien's appeal (for our CAPS community, anyway) lies simply in the fact that it's a spinoff. As we've written many times here at the Fool, spin-offs are beautiful for a variety of reasons -- the most important, of course, being the initial selling pressure that often causes opportunities like this.

As for the business itself, Covidien has always been regarded as Tyco's crown jewel, with plenty of value just waiting to be unlocked. Covidien operates five segments (medical devices, imaging solutions, pharmaceutical, medical supplies, and retail products), and our community loves the opportunities to grow in each of them. Covidien ranks fifth in total sales among other diversified health-care giants like Johnson & Johnson (NYSE:JNJ) and Abbot, but now that management is free from Tyco's bureaucratic shackles, they've ramped up R&D considerably to fight for a bigger piece of the pie.

It's impossible to predict exactly when Covidien's selling pressure will cease, but with a bargain-bin ratio notably lower than its peers, a reinvigorated management team, and CAPS' bullish sentiment, this spin-off might be worth at least a test spin on CAPS.

Now let's hear from the folks at home
CAPS All-Star healthcarevalue likes how COV covers all the bases:

[E]mphasis on medical devices, imaging, and medical supplies as well as pharmaceuticals is a good form of diversification among products, as well as a force for growth going forward. As it is a recent spinoff, there is undue downward pressure on the stock.

Meanwhile, darkflame takes us on a treasure hunt of sorts:

Spin-offs tend to outperform the S&P. The company might be great and all of that, but playing with probabilities it's enough to score. Check the compensation packages in the SEC forms, and it might be that you discover the managers are deeply interested in the company. If so, come back, and thank me.

Finally, imyoung sums it all up with the "Top 5 Reasons Covidien should Outperform":

1. It is a TYCO spin-off: spin-offs usually do better than the parent company,
2. It is a leader and first mover in many medical product categories (many of them well-known brand names),
3. Large salesforce in over 50 countries with extremely high revenue and net      income/employee,
4. About 50% of revenue in non-US currency, and
5. It is currently undervalued.

A Fool's final word
As always, what we say here isn't meant to be taken as a formal recommendation; we want only to generate some possible ideas that you might find worth further research. If you'd like to scour the bargain bin for yourself, read what our CAPS community thinks, or even chime in with your own opinions, click here to get in the game.

Oh, and it's totally free -- an offer that the deepest of value investors should never pass up.

Fool contributor Brian Pacampara has been tracking the stocks used in this column. Currently, TheFrugals are ranked No. 4,350 out of more than 60,000 portfolios. Brian owns no position in any of the stocks mentioned. Covidien is an Inside Value selection. Johnson & Johnson is an Income Investor recommendation. The Fool's disclosure policy always pays the full price for transparency.