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-grabbers who buy them.

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

Company

CAPS Stars
(Out of 5)

2004 Price-to-Book Ratio

Return Since

E*TRADE (Nasdaq: ETFC  )

****

1.91

(88.1%)

Flextronics (Nasdaq: FLEX  )

****

1.23

(47.4%)

American Capital (Nasdaq: ACAS  )

***

1.58

(85.9%)

Saks (NYSE: SKS  )

**

0.84

(40.5%)

Ambac Financial (NYSE: ABK  )

*

1.71

(98.4%)

Sources: Motley Fool CAPS, Capital IQ, Yahoo! Finance.

Watch out!
How can you avoid value traps like these? My favorite method is borrowed from professor Aswath Damodaran. In his book Investment Fables, Damodaran 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 135,000-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 25 stocks that CAPS found hiding in the weeds, Teleflex (NYSE: TFX  ) intrigues me this week. The details for this Motley Fool Inside Value pick:

Metric

Teleflex

Recent price

$45.73

CAPS stars (out of 5)

*****

Total ratings

84

Percent bulls

91.7%

Percent bears

8.3%

Price-to-book

1.24

ROE

20.1%

% Above 52-week low

22.9%

Sources: CAPS, Yahoo! Finance.
Data current as of Aug. 17, 2009.

Teleflex is an old pick for Inside Value­. Advisor Philip Durell singled out the stock in the August 2006 issue of the newsletter. Fortunately, the thesis is timeless: Teleflex combines modest organic growth with small yet strategic acquisitions, resulting in bountiful free cash flow used for, among other things, generous dividend payments.

The numbers are worth eyeballing. From 1997 to 2007, for example, Teleflex increased its dividend payment 12.38% annually, to $1.25 per share. This year, the company is on track to distribute $1.36 for every share held, up another 8.8% from two years ago.

Contrast that with General Electric (NYSE: GE  ) , a much larger industrial conglomerate, which recently reduced its dividend payment to cut costs. Impressive, no? Mix in a commitment to invest only in its most profitable business units, and Teleflex begins to look like a very attractive long-term holding.

But that's just my take. Would you buy shares of Teleflex 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. Teleflex is a current pick. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is also a member of the Motley Fool Rule Breakers stock-picking team. Tim didn't own shares in any of the companies 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.


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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 August 17, 2009, at 2:05 PM, madmilker wrote:

    but feel free to steer clear of tis piece of expensive crap...

    Retail makes nothing and if America is to get all those jobs back......they gotta think made in America.

    People in America need to realize jus what got America in this shape…”cheap” yes so-call cheap items from a foreign land.

    quote*Wal-Mart firmly believes in local procurement. We recognize that by purchasing quality products, we can generate more job opportunities, support local manufacturing and boost economic development. Over 95% of the merchandise in our stores in China is sourced locally. We have established partnerships with nearly 20,000 suppliers in China. *end quote!

    Now! if there be 182 country’s making items for the world to buy and they have only 5% of the pie in China…duh! This company makes the nice people of China support their currency(yuan) by keeping it in their country working for the people there…. but with the “yuan” going up in value and the US dollar going down…all the foreign items that the American consumer buys thinking it is cheap has went up in price.

    People…its all about the currency and to keep a currency strong you got to keep it floating around the country you live in so it can work for you. For the past 12 years all them US dollars are being shipped overseas to a foreign bank and with the American worker not making anything for the foreigner to buy the “we the people” have to turn to the “second” largest employer in America(Uncle Sam) to sell “we the people” debt in order to get all them dollars back!

    50 years ago a foreigner would had given their left nut for a US dollar or a Hershey’s chocolate bar and today the same foreigner has got Uncle Sam and the American consumer by both all the while Hershey is moving the chocolate factory to Mexico. Wake up! America and think “MADE IN AMERICA.”

    quote*"Considering that there are over 30,000 ships at sea this morning," writes James Carlton, director of the Williams College-Mystic Seaport Maritime Studies Program, in an e-mail, "the total number of organisms and species in this global 'bioflow' on the morning your readers read your piece could be staggering - billions of individuals, and thousands of species."

    Indeed, scientists have long considered ballast water the primary way invasive aquatic organisms are introduced. From the zebra mussel's arrival in the Great Lakes, to an American jellyfish severely disrupting Black Sea fisheries, the potential costs of accidental introduction of a species to new homes can be tremendous. Aquatic invasives cost the US $9 billion yearly, according to estimates by David Pimentel, professor emeritus of ecology and evolutionary biology at Cornell University in Ithaca, N.Y. Zebra and quagga mussels (a cousin to the zebra) alone cost the $1 billion annually.*end quote!

    tat is $9 billion a year in hidden taxes to all Americans...

    cheap ain't chic and it cost America............jobs!

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Related Tickers

11/21/2014 4:01 PM
TFX $116.35 Up +0.99 +0.86%
Teleflex CAPS Rating: ***
ABKFQ.DL $20.40 Down +0.00 +0.00%
Ambac Financial Gr… CAPS Rating: ***
ACAS $14.88 Down -0.07 -0.47%
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ETFC $23.03 Up +0.20 +0.88%
E*TRADE Financial… CAPS Rating: ***
FLEX $11.10 Up +0.07 +0.63%
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SKS.DL2 $0.00 Down +0.00 +0.00%
Saks, Inc. CAPS Rating: *

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