Don't Miss This Cheap Stock

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Cheap stocks can get cheaper. They often do.

Unfortunately, "cheap" is a relative term. Precious few stocks that trade for low price-to-earnings ratios or below book value are real bargains. They look enticing but are instead value traps -- stocks that deserve the multiples for which they trade and punish the Dumpster-divers who buy them.

But don't take my word for it. Here are five "cheap" stocks that trapped bargain-hunting prey:

Company	CAPS Stars (5 max)	2004 Book Value	Return Since
Coherent (Nasdaq: COHR)	**	1.38	(32.2%)
MFA Financial (NYSE: MFA)	**	1.21	(11.2%)
Centex (NYSE: CTX)	*	1.90	(79.6%)
Pulte Homes (NYSE: PHM)	*	1.77	(56.5%)
Jo-Ann Stores (NYSE: JAS)	*	1.82	(41.9%)

Sources: Motley Fool CAPS, Capital IQ.

Watch out!
How can you avoid value traps like these? My favorite method is borrowed from professor Aswath Damodaran, author of Investment Fables. In it, he counsels investors to measure low price-to-book stocks by their returns on equity (ROE).

Makes sense to me. Book value is shorthand for equity. A low price-to-book stock is priced as if management won't produce high returns from the equity capital afforded it. Find a stock that defies this maxim -- a stock with an above-average-and-rising ROE -- and you may have found a bargain.

A machete for when you're in the weeds
Our 130,000-member-strong Motley Fool CAPS database is a great place to start your search. I ran a screen for well-respected stocks trading for less than twice book value and whose returns on equity were 10% or more. Qualifiers were also trading no more than 25% above their 52-week low, leaving plenty of room for further gains.

Of the 74 stocks that CAPS found hiding in the weeds, it's wannabe oil emperor Chevron (NYSE: CVX) that intrigues me this week. The details:

Metric	Chevron
Recent price	$66.58
CAPS stars (5 max)	****
Total ratings	3,064
Percent bulls	95.2%
Percent bears	4.8%
Price-to-book	1.54
ROE	27.6%
% Above 52-week low	19.9%

Sources: CAPS, Yahoo! Finance. Data current as of April 14, 2009.

Interestingly, it's Iraq that has CAPS bulls like mtinvest running toward Chevron. Quoting from a pitch this investor posted last week:

I would rather invest in Gazprom of Russia, PetroChina (subsidiary of state owned CNPC), Petronas of Malaysia, [Petrobras (NYSE: PBR)] of Brazil that keep increasing their reserves. But now that Chevron and Total are about to be in control of the Iraqi oil fields, they seem interesting.

Now does that strike you as a stock that should be trading for less than the industry average? Not me. And yet, at 5.7 times earnings, Chevron is priced as if it's a member of Team Energy's junior varsity. Crazy.

But that's my take. Would you buy shares of Chevron at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate. See you back here next week with more bargain basement Foolishness.