Don't Miss This Cheap Stock

Cheap stocks can get cheaper. They often do.

The problem is that "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 Rating
(5 stars max.)

2004 Book Value

Return
Since

Saks (NYSE: SKS  )

*

1.01

(67.9%)

Tyson Foods (NYSE: TSN  )

**

1.20

(34.5%)

Celera (NYSE: CRA  )

***

1.10

(32.2%)

Stillwater Mining (NYSE: SWC  )

***

1.12

(57.7%)

IAC/InterActive (Nasdaq: IACI  )

***

1.56

(79.4%)

Sources: Motley Fool CAPS, Capital IQ.

Watch out!
How can you avoid value traps like these? My favorite method is borrowed from professor Aswath Damordaran, 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 125,000-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. As a qualifier, the candidates also had to trade no more than 25% above their 52-week low, leaving plenty of room for further gains.

Of the 176 stocks that CAPS found hiding in the weeds, Allied Irish Banks (NYSE: AIB  ) intrigues me most this week. The details:

Metric

Allied Irish Banks

Recent price

$5.63

CAPS stars (5 max)

*****

Total ratings

2,018

Percent bulls

97.2%

Percent bears

2.8%

Price-to-book

0.18

ROE

20.6%

% Above 52-week low

23.7%

Sources: CAPS, Yahoo! Finance, Capital IQ. Data current as of Jan. 6, 2009.

Impressive numbers, eh? I'll say. Here's one more: Owners of Allied Irish Banks yield -- wait for it -- 35% from dividends at current prices. A 35% return with no capital appreciation required. That's astounding.

But it may also prove too good to be true. If the current financial crisis has taught us anything, it's that banks such as Citigroup (NYSE: C  ) can lose equity just as fast as they earn it -- especially if the value of the equity-producing assets, the ones responsible for Allied Irish's super-low price-to-book ratio, are overstated.

And yet, there's still a lot to like about Allied's position, writes CAPS All-Star BigDMan64. Quoting from his recent pitch:

I hate banks and financial services. I shorted many of the regional banks about a year ago with much success. I am not in favor of the bailouts which appear to be used both in the US and Europe to purchase additional deposits rather than increase liquidity. That having been said, this pick is a no brainer. Ireland may be the soundest economy in Europe. Other than Lloyds and National Bank of Greece, this company has the best management with a conservative track record and holds little, if any bad paper.

Allied Irish might not have much bad paper, but that didn't stop the Irish government from stepping in. It forced Allied Irish to take 2 billion euros of capital, in return for preferred stock paying 8% interest. That will have to be paid before any dividends can reach common shareholders. Thus, the question remains: Will Allied Irish be able (and willing) to pay its dividend in 2009?

What do you think? Is Allied Irish Banks the bargain it appears to be, or a value trap waiting to snap? 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.

Beginning Jan. 12, 2009, Fool co-founder David Gardner, Jeff Fischer, and their Motley Fool Pro team will accept new subscribers to their real-money portfolio service. Motley Fool Pro is investing $1 million of the Fool's own money in long and short positions in a range of securities, including common stocks, put and call options, and exchange-traded funds (ETFs). They also incorporate proprietary CAPS "community intelligence" data into their research. To learn more about Motley Fool Pro and to receive a private invitation to join, simply enter your email address in the box below.

Allied Irish Banks is a Motley Fool Global Gains recommendation. The Fool owns shares of Allied Irish Banks.

Fool contributor Tim Beyers also contributes to the market-beating Rule Breakers service. Tim didn't own shares in any of the stocks mentioned in this article at the time of publication. Check out his portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. Its disclosure policy is a bargain at any price.


Read/Post Comments (12) | Recommend This Article (12)

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 January 13, 2009, at 6:24 PM, TMFTheDoctor wrote:

    Tim, AIB had a yearly and a half-yearly dividend, and they already cut the larger yearly dividend (and dropped quite a bit immediately following, which of course ramped up the remaining dividend). Who knows if the half-yearly will stay. I'm not too sure about Ireland being the best economy in Europe either, considering they were the first to announce they were in a recession. Celcticspirit on the AIB public board has a lot of good insight into the Irish economy. AIB is certainly the strongest of the Irish banks but with the government trying to step in and fix things, there's too much uncertainty. A lot of banks look cheap until the government decides to wipe shareholders out take a controlling interest to "save" them. I've been keeping an eye on AIB for a few months now but until the government lets it cross the street on its own, I'm not getting near it.

  • Report this Comment On January 14, 2009, at 12:32 PM, billkeo wrote:

    AIB bankrolled real estate developers who now own what the Irish call "ghost estates" which are developments in which houses have been empty for a year or more because nobody wants them. Since the developers can't sell the houses, they probably will have trouble paying off their AIB loans. Dell Computer, Ireland's second-largest employer, also has announced that it's leaving the country and taking all its jobs with it. This could impact AIB deposits.

  • Report this Comment On January 16, 2009, at 9:08 AM, steven107 wrote:

    If you really do believe that it is a cheap stock that can't be missed, then wait for the short wait period for being a fool author to be over and put some money into play. I see from your current portfolio, you don't currently own any. I bet you just can't wait for the days to tick by so that you can jump on it.

    My point is the way you all write these articles seems like you got something to sell. If you are just writing about a good buy, why aren't you writing about the things that you have bought.

    Here is what your profile says is in your portfolio, limit your writings to these, if you want to expand your articles, expand your portfolio.

    Stocks TimBeyers Owns: AAPL (common and LEAPs), ACAS, AINV, AKAM, ALVR, ATRO, ATSX.OB, BRKb, CMG-B, GOOG (common and LEAPs), GU, IBM, IPG, LULU, MVL (common and LEAPs), NOK, ORCL, PSEC, SIMO, TINY, TSM

  • Report this Comment On January 16, 2009, at 10:21 AM, kgeechee wrote:

    AIB: Another Investment Bomb from your friend, Motley Fool. How about publishing the glowing reports from your trip to Dublin to see this wonderful opportunity.

    Note the following: "The funding position of the bank has weakened and unacceptable practices that took place within it have caused serious reputational damage to the bank .....Lenihan was referring to the scandal that rocked the bank last month when it was revealed that its then-Chairman Sean FitzPatrick hadn't fully disclosed 87 million euros of loans he received from the bank. FitzPatrick, CEO David Drumm and finance director Willie McAteer all resigned in the wake of the scandal, undermining the bank's already weak shares.

    While shares in Anglo Irish were suspended Friday, they had previously lost around 98% of their value since the start of 2008.

  • Report this Comment On January 16, 2009, at 1:22 PM, gadfly1000 wrote:

    Is the previous writer confusing Allied Irish with Anglo Iris?

  • Report this Comment On January 16, 2009, at 1:23 PM, gadfly1000 wrote:

    Sorry, Anglo Irish.

  • Report this Comment On January 16, 2009, at 1:24 PM, gadfly1000 wrote:

    Sorry, Anglo Irish

  • Report this Comment On January 20, 2009, at 9:20 AM, clawmann wrote:

    FitzPatrick is the disgraced ex-chairman of Anglo Irish, not Allied Irish (AIB).

    And if the stock looked cheap then, in today's (jan 20) premarket, its down to about 1.20. The huge drop is attributed to (in my view, panicky) speculation that AIB wil be nationalized, as was Anglo Irish. But Eugene Sheehy, AIB's CEO, just issued (around 8 am EST, Jan. 20) a PR re-affirming his belief that AIB will not be:

    http://www.irishtimes.com/newspaper/breaking/2009/0120/break...

    Sheehy states:

    "AIB continues to be a strong, sound, internationally diversified organisation which serves a huge range of personal and business customers across a wide variety of sectors." and "We have the depth and strength required to manage our way through this period of uncertainty as an independent organisation and I believe we will do so."

    Soooooo, today's price represents either one of the best long term bargains on the market or fool's gold.

    For my part, I believe the Irish Government's very recent statements indicating that only Anglo Irish will be nationalized. If these turn out to be true, then AIB stock at $1.20 a share is pretty darn attractive. In any event, even if AIB is nationalized, the Irish government would legally be on the hook to pay the shareholders "just" or "adequate" compensation (which they are going to pay to the shareholders of Anglo), and it is hard to believe that the compensation owed to AIB shareholders would not approach the current share price.

    BTW, the compensation requirement is found not only in Ireland's constitution and laws, but in the European Convention on Human Rights, to which Ireland is a signatory. And that requirement is legally enforceable both in the courts of Ireland and the European Court of Human Rights.

    Ireland is not Venezuela.

  • Report this Comment On January 20, 2009, at 9:27 AM, clawmann wrote:

    Government to nationalise Anglo Irish Bank

    http://www.ireland.com/home/Government_to_nationalise_Anglo_...

    "Mr Lenihan [Minister for Finance, Ireland] pledged that the Government will respect shareholders’ rights in the nationalisation process. 'The relevant legislation outlines a process for determining compensation as appropriate,' he said."

  • Report this Comment On January 20, 2009, at 9:51 AM, jettrey wrote:

    And AIB just tanked (down 71% this morning).

    I don't keep my CAPS stuff updated, but I bought AIB a long time ago for the dividends. Wish I had dumped it a long time ago now. Glad I didn't follow this advice and buy more. I don't expect the dividends to keep up. (Sort of like TMA, which my father-in-law bought for the yield, same mistake. For fun, check out their current yield, it shows as 4950%... sadly last paid a year ago.)

  • Report this Comment On January 20, 2009, at 10:10 AM, clawmann wrote:

    Today, jan 20, at 10 am EST:

    Fin min: AIB, Bank of Ireland to remain private

    http://www.reuters.com/article/rbssFinancialServicesAndRealE...

    "DUBLIN, Jan 20 (Reuters) - Irish Finance Minister Brian Lenihan said on Tuesday it was the government's intention that the country's biggest lenders Allied Irish Banks (ALBK.I) and Bank of Ireland (BKIR.I) remained in private ownership."

    "The government has pledged to inject 2 billion euros ($2.6 billion) each into the two banks giving the state a 25 percent stake in each."

    "Lenihan said the government wished to ensure the two remained independent banks."

    "The government re-affirms that it is proceeding with the planned recapitalisation of Bank of Ireland and Allied Irish Banks on this basis and its firm intention is that both banks remain in private ownership," Lenihan told deputies."

    In my opinion, today's huge drop in AIB's share price is a panicked reaction to unfounded rumours and speculation about AIB's potential nationalization.

  • Report this Comment On January 22, 2009, at 3:35 PM, steven107 wrote:

    Congratz, Unlike me, Tim will get to buy his shares for $1.

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