With all of the recent volatility in the market, which stocks are outrageously cheap?

I found one recently, and I got to thinking about the others out there when I read money manager Bill Miller's comment that "the market abounds with good value." Of course, Miller also wrote last August that stocks were the cheapest they'd been since 1991 ... and after a brief rebound, they've gone right on dropping. It's so bad, in fact, that former giants AIG (NYSE:AIG) and Eastman Kodak (NYSE:EK) are now real-life penny stocks.

Given wary financial markets, a recent rash of writedowns, and a slowing economy, it should be clear that not all stocks that look cheap are cheap (with no disrespect intended to the talented Miller). Both Warren Buffett and John Hussman have recently affirmed that lesson.

There are, however, some individual stocks today that, for one reason or another, not only present "good value" but are outrageously cheap.

Back up the truck, people
What makes for an outrageously cheap stock? Here's my short list:

  1. A balance sheet with lots of cash and little debt.
  2. An EV/EBITDA ratio less than 6.
  3. A business with the financial strength and strategy to survive and thrive in a down economy.
  4. No potential for massive writedowns.
  5. A stock that's been pummeled.

Of course, even amid today's unprecedented market environment, I can't find a single large-cap stock that meets those criteria, so if you really want to build an "outrageously cheap" portfolio, you may need to start thinking of yourself as a small-cap investor.

Welcome to the jungle
In truth, large caps attract far too much investor attention to ever become inefficiently priced. Intel (NASDAQ:INTC), for example, is followed by 48 sell-side analysts. If you're going to buy the stock, you have to ask yourself: What are they missing that you aren't? In fact, there are only a few mid caps -- Coach (NYSE:COH) among them -- that meet my outrageously cheap criteria.

You generally won't find as much interest among small caps, which is one of the reasons why -- given the criteria above -- Under Armour (NYSE:UA), Diamond Management & Technology Consultants (NASDAQ:DTPI), and Drew Industries (NYSE:DW) look outrageously cheap.

Company

EV/EBITDA

Net Cash
on Hand

Investors Scared Because ...

UnderArmour

5.6

$57 million

Declining consumer spending threatens sales.

Diamond Management

2.7

$42 million

Customer base concentrated in the financial industry.

Drew Industries

2.9

$0 million

Tied to the RV industry, which was first hit by high gas prices and now hit by economic downturn.

Data from Capital IQ, a division of Standard and Poor's.

Yes, that last subhead was a Guns N' Roses reference
The reason we love being small-cap investors at Motley Fool Hidden Gems is because it's the one area of the market where, thanks to inefficiencies and lack of Wall Street interest, stocks can become outrageously cheap. And there's good reason to think that things will get better for all three of these stocks. Of course, in a down market like this one, that lack of efficiency can make for some gut-wrenching downside volatility. And the problems facing these generally well-run companies are undoubtedly real.

But we're using current market conditions to recommend the market's best small companies -- stocks that should crush the market averages over the next decade or more.

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This article was first published on March 14, 2008. It has been updated.

Tim Hanson owns no shares of any company mentioned. Under Armour and Drew Industries are both Motley Fool Hidden Gems recommendations; Under Armour is also a Rule Breakers pick. Intel is an Inside Value pick. The Fool owns shares of Under Armour, owns covered calls on Intel, and has a disclosure policy that is decidedly un-outrageous.