This Is the Market's Cheapest Stock

You may never have heard of Arkansas Best, but its 462% gain between 1999 and 2009 makes it one of the great success stories of the past decade or so.

So what made Arkansas Best so special? A decade ago, the stock was cheap. And I mean dirt cheap.

Using Capital IQ, an institutional database, I ranked the 1999 stock universe by price-to-sales, price-to-earnings, and price-to-book multiples, and ordered the stocks by their combined rankings. Based on how it stacked up against the rest, Arkansas Best was literally the market's cheapest stock. It was one of those rare "no-brainer" bets that made a small number of savvy investors rich:

Data from Capital IQ, a division of Standard & Poor's; includes companies traded on major U.S. exchanges with market capitalizations greater than $100 million.

One company out there today looks remarkably similar to Arkansas Best before its spectacular run -- KV Pharmaceutical (NYSE: KV-A), recently the market's cheapest stock.

Data from Capital IQ as of Feb. 19, 2010.

This looks pretty much like a "can't-lose" investment. Even if its earnings never grew, with a P/E of around 2, you'd theoretically make all of your money back in about two years.

Except ...

Tomfoolery aside ...
I'm sure that recent events can pretty easily illustrate the fallacy in that line of thought.

In early 2008, Citigroup was trading for less than book value. But billions in losses later, the stock is down some 80%, and it could still be a huge value trap.

Why? Because no one -- not investors, not financial pundits, not management, not even The Man Upstairs -- knows what their inscrutable assets and liabilities are. If you don't believe me, please turn to pages 38-44 of Citi's most recent 10-Q filing for a summary of its TARP, subprime, and global risk exposure, and to pages 45-53 for derivatives. (I'll save you some time: It's long, and there are lots of big, boring numbers.)

See, the trouble with backward-looking multiples -- especially in this unusual environment -- is that they're, well, backward-looking. They don't take into account future business prospects.

So despite being the market's cheapest stock on a trailing-multiple basis, KV wouldn't necessarily be a great stock for you to buy. While the company has enjoyed tremendous growth in recent years, it's had to lay off workers and suspend some of its products pending an FDA inspection.

Moreover, it recently replaced its chief financial officer, and nearly faced delisting from the New York Stock Exchange because it still has not submitted its 2009 annual report (which had been due in March, but was delayed because of an internal audit investigation and the company's reorganization efforts). If you're interested in buying KV, those are just a few things you'd want to look into first.

Despite its numerical "cheapness," KV might not be as great a stock as, say, Apple (Nasdaq: AAPL), whose P/E is a somewhat lofty 22. While KV sorts out the aforementioned problems, Apple continues to grow, has $25 billion in net cash, and generates substantially more free cash flow than net income.

But just in case you're curious ...
You may be interested to see how much money you could have made buying the lowest-multiple stocks in the past:

Data from Yahoo! Finance and Capital IQ, a division of Standard & Poor's.

Those are some impressive, albeit inconsistent, gains. Of course, you could have made even more money investing in a number of other value stocks, though they may have appeared somewhat pricier based on a cursory look at their multiples. Consider these monster performers:

Data from Yahoo! Finance and Capital IQ, a division of Standard & Poor's.

While this comparison is by no means a conclusive survey, we can draw a couple of important conclusions:

1. With some valuations so depressed right now, investors today are likely to see a number of strong performers in the coming years.
2. The "cheapest" stocks on a multiples basis are not always the best value stocks.

Point taken
While I've shown you which name the multiples tell us is the market's cheapest stock, I should caution that it's not one I would recommend buying. As investors, we should always keep in mind that valuation is a forward-looking exercise that requires anticipating how the company will perform under future conditions.

At Inside Value, The Motley Fool's value investing service, we also consider a company's competitive position, its market opportunities, its relationships with customers and suppliers, and the quality of its management when building our models. Our Inside Value team has identified several bargain stocks that also have the competitive positioning to thrive in this market. You can click here to read about our favorite stocks, free for the next 30 days. There's no obligation to subscribe.

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This article was originally published May 22, 2009. It has been updated.

Ilan Moscovitz owns shares of Apple, a Stock Advisor recommendation. Sasol is both a Global Gains and Income Investor pick. The Fool has a disclosure policy that makes us all proud.