3 Cheap Stocks Our Experts Like Right Now

It took a special kind of incompetence to get to where we are today. After years of "producing" billions of dollars using sophisticated financial instruments, we saw investment banks like Lehman Brothers and nominal retail banks like Citigroup get crushed by the consequences of excessive leverage and convoluted investments. Good thing we've stopped trusting our finances to what those bozos have to say.

Yeah, good thing
Then again, maybe we haven't completely. Case in point: Analyst forecasts.

It's a well-documented fact that analyst earnings estimates tend to be wildly inaccurate -- off by some 40% on average, according to an extensive study by two Penn State professors. Then there's the herd mentality that figures into buy and sell recommendations. In his book One Up on Wall Street, legendary former Fidelity Magellan fund manager Peter Lynch explains why so many Wall Street analysts copy each other, rather than risk their reputations on unusual opinions: "Success is one thing, but it's more important not to look bad if you fail."

See, as my colleagues Brian Richards and Tim Hanson revealed in a recent column, the trouble with analyst price targets is

  1. You get no context.
  2. The vast majority of stocks -- not surprisingly, for an industry that makes money by persuading you to buy stocks -- are considered "undervalued."

Really? The vast majority?
Yes. According to data I've collected using Capital IQ, an institutional software package, the Wall Street consensus considers fully 85% of S&P 500 companies to be undervalued.

Consider these standouts:

Company

Recent Price

Consensus Target Price

Upside Potential

Southwest Airlines (NYSE: LUV  )

$6.31

$11.00

75%

GameStop (NYSE: GME  )

$21.83

$32.50

49%

Chesapeake Energy (NYSE: CHK  )

$19.56

$28.70

47%

Valero (NYSE: VLO  )

$16.03

$22.50

41%

Pfizer (NYSE: PFE  )

$14.72

$19.10

30%

While these are excellent companies, and it may be comforting for us to see lofty analyst price targets attached to our stocks, it's absurd to think that the vast majority of the S&P 500 -- an index that captures the most carefully scrutinized publicly traded companies -- would be undervalued.

Remember, many of these recommendations come from the same Wall Street firms that couldn't properly analyze their own businesses. And while that doesn't mean none of them employs very capable analysts or that no stocks are undervalued today (many are), it does raise another problem with price targets.

3. You have no way of assessing the analyst's past record.

If all you have to go on is that someone at UBS likes Pfizer, how on earth are you supposed to estimate the quality of the analysis, much less decide whether you agree with the opinion?

You can't
That's one of the reasons why we created Motley Fool CAPS, a 135,000-member database that ranks investors by how well their stock picks perform relative to the S&P 500. Those whose track record places them in the top 20th percentile are the cream of the crop. We like to call them "All-Stars."

Here are three stocks those expert investors love right now:

Company

All-Star Outperform / Underperform Ratings

Percent All-Star Bulls

Procter & Gamble (NYSE: PG  )

1,753 / 22

99%

Johnson & Johnson (NYSE: JNJ  )

3,049 / 54

98%

Activision-Blizzard

1,360 / 31

98%

Source: Motley Fool CAPS and Yahoo! Finance.

Today, I'd like to give you more information about one of these names -- Activision.

As Fool co-founder David Gardner wrote for Motley Fool Stock Advisor members in 2002, "the Tony Hawk series of extreme skateboarding games ... [has] been a huge hit. The series has opened the way for other extreme sports action games, giving Activision a strong niche presence [that] has created nice sustainable profitability."

On the strength of its games' popularity, Activision grew earnings from $52 million to some $230 million over the next five years. The company recently acquired Vivendi's Blizzard, which augments its existing stable of Call of Duty and Guitar Hero -- the No. 1 and No. 2 console games, respectively -- with World of Warcraft's 11.5 million online subscribers.

David wrote again last fall, "Hot new releases in the top-selling Guitar Hero franchise will strike a chord with shoppers this holiday season, while new titles, additional revenue opportunities, merger boons, and Blizzard's superior margins will set the newly combined company on the path to a fast-swelling bottom line." David still thinks Activision's a great stock, and more than 1,000 CAPS experts agree.

While Activision is up more than 250% for Stock Advisor members, it isn't the only pick that's outperforming. Despite launching the service in the midst of the last bear market, the average Stock Advisor recommendation is beating the S&P by more than 40 percentage points. If you're looking for some more stock ideas, click here to see Fool co-founders David and Tom Gardner's favorite stocks right now, free for the next 30 days. There's no obligation to subscribe.

Ilan Moscovitz owns shares of Google, a Rule Breakers selection. Chesapeake Energy and Pfizer are Inside Value recommendations Activision-Blizzard and GameStop are Stock Advisor selections. Johnson & Johnson and Procter & Gamble are Income Investor picks. The Fool owns shares of Procter & Gamble and has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (25)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 26, 2009, at 2:24 PM, yaldezian wrote:

    Nice article. I noticed that there were links to the stocks except for Activision. Any reason? Or, oversight?

    Their ticker is ATVI, and shares are selling for around 12.70

  • Report this Comment On July 09, 2009, at 8:11 AM, 8k2u7FxK3QqlagX wrote:

    "the average Stock Advisor recommendation is beating the S&P by more than 40 percentage points"

    I see this stated at the end of nearly every article I read on MF. Can someone please explain what this means and how its calculated? Its repeated so often, it must be important information.

    Thanks.

  • Report this Comment On July 09, 2009, at 9:40 AM, 8k2u7FxK3QqlagX wrote:

    oops, forgot the equally enigmatic introductory "Despite launching the service in the midst of the last bear market,...". If you're talking about relative performance, what does it matter at what level the market was at the start, and wouldn't there be more compelling values available in the bear market period?

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