Don't Miss This Cheap Stock

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 garbage-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

Reliant Energy (NYSE: RRI  )

***

0.59

(54.3%)

Service Corp. International (NYSE: SCI  )

***

1.52

(49.9%)

HRPT Properties Trust (NYSE: HRP  )

***

1.05

(44.9%)

MI Developments (NYSE: MIM  )

*

0.84

(70.5%)

Apartment Investment & Mgmt. (NYSE: AIV  )

*

1.45

(57.4%)

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 130,000-member 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 65 stocks that CAPS found hiding in the weeds, it's NTT DoCoMo (NYSE: DCM  ) that intrigues me this week. The details:

Metric

NTT DoCoMo

Recent price

$13.36

CAPS stars (5 max)

*****

Total ratings

95

Percent bulls

91.6%

Percent bears

8.4%

Price-to-book

1.29

ROE

12.1%

% Above 52-week low

9.3%

Sources: CAPS, Yahoo! Finance, Capital IQ.
Note: data current as of April 7, 2009.

Interestingly, 17 of the 95 investors who've rated this Japanese mobile carrier entered their picks this year. Of those, eight are in the top 20% of CAPS investors and every one of them is bullish.

Strong financials might help to explain that. In January, NTT DoCoMo reported that its net profit for the nine-month period ended in December rose 16% over the comparable period in 2007. Operating income rose 19%. Revenue fell 4% but fewer subscribers left for rival services. Acquisition costs apparently declined noticeably.

NTT DoCoMo may be profiting from Apple's (Nasdaq: AAPL  ) failure to make the iPhone a hit in Japan. Carrier rival SoftBank Mobile is giving away the 8-gigabyte version of the handset to those who sign a two-year service contract, reports blogger CrunchGear.

Talk about irony. Apple CEO Steve Jobs was, at one time, courting NTT DoCoMo to be its carrier partner. No longer, and yet the company is profiting. Color me impressed.

But that's my take. Would you buy shares of NTT DoCoMo 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.

Want further guidance? Get 30 days of free access to the Fool's Inside Value service, which spotlights stocks that Mr. Market has put on sale.

Fool contributor Tim Beyers is also a member of the Rule Breakers team. At the time of publication, he had stock and options positions in Apple, a Stock Advisor selection. 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.


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