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 kindred stingy 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 into 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.

Oh, baby!
When our value guru Philip Durell recommended baby-clothes maker Carter's to Motley Fool Inside Value subscribers, the bargain became pretty clear to Fool nation. Out of the 149 players who've rated Carter's on CAPS, only one brave soul is crying "underperform." It seems that even Mr. Market couldn't resist, carrying the shares up 11% since the pick was made two months ago.

Carter's stock is adorable for a simple reason: The company holds the No. 1 share in the baby-apparel market. On average, it sells more than 10 products for every child born in the United States. Now that's what I call business, baby. What's more, through its acquisition of OshKosh B'Gosh, Carter's is now the leading provider of apparel for children up to 7 years old. Of course, having quality, well-respected brands essentially means nothing if others aren't willing to pay up for them, so fortunately, Carter's also has the pricing power to boot -- or should I say booties?    

Carter's has maintained operating margins eerily close to 14% in each of the past five years, all while growing its top line at a compounded rate of 21% over the same period. It has also announced a $100 million buyback program, giving management another option in putting the healthy cash flow to work. It's no secret that buying an industry's best puppies can be rewarding, but when combined with a bargain-bin price, the odds can only get better.

Now, just as no toddler is perfect -- despite what his or her parents think -- no investment is without its flaws, either. Even Carter's has lackluster same-store-sales results and long-term debt of roughly $340 million, working out to a debt-to-equity ratio of 0.72. However, for Fools looking for a widely known industry leader to bring into the family, Carter's may be worth all the headaches. Here are three CAPS players who think this baby's got plenty of room to grow:

• CAPS player rungeek27 uses some deductive reasoning to make his call: "They make great children's clothing, and have established themselves as a solid brand name. ... The fact that my wife and her friends drive 30 or more minutes every two to three months to outfit my children tells me theirs is a quality product."

• Similarly, CAPS All-Star dymaxian takes the "buy what you know" approach: "One of the most respected baby clothing brands. Being a new father, this is an obvious pick for me, right along with Johnson & Johnson and Procter & Gamble. I see those three names in every room in my house. You don't stop buying baby stuff in a down market."

• Finally, TrackMyPics touches on the price potential: "Great quality clothes, serving the middle-market consumer. Great locations, for both retail and outlets. Only downside would be serious fashion misses by management. Negatives have already been priced in, and I can see upside from here on."

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, to read what our CAPS community thinks, or even to chime in with your own opinions, click here to get in the game.

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

Carter's is a Motley Fool Inside Value pick. A free 30-day trial to the services is yours.

Unconvinced about the power of cheap picks? Fool contributor Brian Pacampara has been tracking the stocks used in this column. Currently, TheFrugals are ranked 45 out of 31,531 rated portfolios. You can check it out here. Brian owns no position in any of the stocks mentioned. Johnson & Johnson is a Motley Fool Income Investor choice. The Fool's disclosure policy always pays the full price for transparency.