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 at low price-to-earnings ratios or below book value are real bargains. They look enticing, but they're actually value traps -- stocks that deserve the multiples for which they trade and punish the trash-pickers who buy them.

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

Company

CAPS Stars (5 max)

Price-to-Book Ratio In 2004

Return Since

Integrys Energy Group (NYSE: TEG  )

***

1.67

(31.7%)

Micron Technology (NYSE: MU  )

**

1.75

(68.3%)

Emulex (NYSE: ELX  )

**

1.50

(42.7%)

Arch Chemicals (NYSE: ARJ  )

**

1.97

(14.6%)

Redwood Trust (NYSE: RWT  )

*

1.65

(43.1%)

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. In his book Investment Fables, 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 73 stocks that CAPS found hiding in the weeds, AT&T (NYSE: T  ) intrigues me this week. The details:

Metric

AT&T

Recent price

$25.50

CAPS stars (5 max)

****

Total ratings

4,498

Percent bulls

94.3%

Percent bears

5.7%

Price-to-book

1.57

ROE

13.4%

% Above 52-week low

22.0%

Sources: CAPS, Yahoo! Finance.
Data current as of April 23, 2009.

I'll admit to having my doubts about the old Bell belle. She's been a drag on the iPhone in the past. Even so, my or anyone else's personal complaints notwithstanding, there's no doubt that AT&T's position as Apple's (Nasdaq: AAPL  ) exclusive smartphone distributor here in the U.S. has paid off big.

And there's more to AT&T than just the iPhone, argues CAPS investor podnificent:

[N]ot a lot of people know about their Uverse offering. I've heard nothing but glowing recommendations and, with this offering, they should be able to give Comcast and others some much needed competition for the home ent space. Throw in their dominant position in wireless and landline (while dying) and you've got a recipe for success.

I'm not sure I'd go that far, but with the stock trading for less than 12 times trailing earnings and paying a 6.4% dividend yield, the gamble seems worthwhile.

But that's also just my take. Would you buy shares of AT&T at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate.

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. Apple is a Stock Advisor selection.

Fool contributor Tim Beyers is also a member of the Rule Breakers team. He had stock and options positions in Apple 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 (2) | Recommend This Article (19)

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 May 01, 2009, at 3:33 PM, Ironbob wrote:

    Someone smarter than I am will have to explain this article because on the surface, it looks really stupid. Tracking a stock from 2004 then judging it's performance when one takes into account the last nine months makes no sense to me at all.

    Case in point, I bought into TEG 3 months ago at 21. Why would I care what happened from 2004-2008 when it's returned me about 45% since then?

    I mean is this guy really serious? You could find a thousand stocks that would fit into the category he is describing.

    Two days after he writes this, TEG is up over 2.50 a share (9.6%) and go check out the upgrades for it:

    http://finance.yahoo.com/q/ud?s=TEG

    They posted losses this quarter but 290 million of it was from goodwill for the divestiture of IEG.

  • Report this Comment On June 11, 2009, at 2:58 PM, Samskara wrote:

    There's an interesting pattern to the complaintrs about ATT -- they're largely from iPhone users, upset that they can't get a discount on the new model before they would be entitled to under the terms of their contract. Of course the contract duration is intended to provide adequate payback for the discount on the phone. Overall customer satisfaction as measured by Consumers Reports is very close to Verizon, the market leader. Meanwhile, Verizon may have the best network by CUs measure, but customers object to the way the company locks the features on their phones. This implies that the early adopters and technophiles who flocked to the iPhone (and now want discounts on the new models before the old ones are paid for) won't be any happier with Verizon, or anybody else. But meanwhile, ATT is doing all it can to position itself as the smartphone leader. This may be important as the now mature market evolves. People focused on costs may head to pre-paid plans such as Virgin or Boost, while ATT may have an edge among more profitable customers. Over the next year or two, Verizon may be forced to play catch-up, and if they get the iPhone will inherit the most disaffected customers, giving the impression that they have lower satisfaction. Sprint, unfortunately, may never be able to get back in the game. It will balance out, but for now, ATT may be in the best position of the three, and that dividend just sweetens the deal.

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