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3 Beaten-Up Cheap Stocks: Are They Bargains?

By Brian Feroldi – Aug 31, 2016 at 8:07PM

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These three cheap stocks have fallen drastically over the past year and trade at low valuations, but are they bargains or value traps?

Image source: Getty Images.

One sound investing strategy is to buy shares of good companies that are temporarily trading on the cheap. Investors who can do so successfully stand a good chance of earning above-average returns once the market reinflates the company's valuation.

Of course, that's easier said than done, as many times companies trade on the cheap because their future is looking grim. That could make the stock a value trap, so investors should be wary about buying stocks just because they are cheap.

With that in mind, here's a list of three cheap stocks that have been beaten down hard over the past year. Let's take a closer look at each to see if any of them might be worth buying.

1. Fossil Group

Investors in the luxury watchmaker Fossil (FOSL -4.17%) have had a rough couple of years. Since peaking in late 2013, shares have been in free fall, and over the last year they have plunged by more than 53%. That's pushed the company's valuation below 10 times trailing earnings, which is a dirt cheap price.

It's not hard to understand why the markets have pummeled the company's stock. Profits have been heading in the wrong direction for quite some time as the company has had difficulty selling its premium products in a tough retail environment. That trend was evident in the company's second-quarter earnings report. Sales dropped by 7% and earnings per share dropped by 50% on the back of continued weakness in the company's watch sales. 

To help turn the ship around, the company is reprioritizing its Fossil and Skagen brands over its licensed products, and it's investing in its digital and omnichannel capabilities. Fossil also has announced plans to become a big player in the wearables market, which appears to be where the company believes consumer spending is heading.

That sounds like a decent plan, but Wall Street isn't hopeful that these moves will turn around the company's fortunes anytime soon. Current projections call for annual EPS to sink by 36% this year and decline by more than 2% annually over the next five years. Numbers like these make me believe that investors should avoid this company's stock like the plague, no matter how cheap it may become. 

2. Macy's

It's tough to be a big-box retailer these days. The ever-present threat from online retailers mixed with softening consumer spending has investors fleeing the space, which has caused shares of Macy's (M -2.16%) to drop by more than 32% over the past year. I'd argue that the drop is warranted given that the retailer recently reported a drop in both earnings and revenue, and laid out a plan to close 100 stores

Image source: Macy's.

In light of those headlines, it sounds like this company is doomed, but there's actual evidence to suggest the opposite. Management stated that they are closing the stores even though many of them are cash flow positive, because they do not yield an adequate return on investment. In addition, the company believes that these stores do not represent a customer shopping experience that reflects the company's aspirations. By closing the stores now, Macy's can simultaneously protect its brand, reinvest in its most productive stores, and build out its digital and mobile channels.   

In a sense, this strategy boils down to short-term pain but long-term gain, which could prove to be a brilliant move. 

Believe it or not, Wall Street is on board with this. While analysts are projecting an earnings drop of more than 10% this year, over the next five years they foresee EPS growth of more than 11% annually. With shares trading for about 11 times forward earnings, Macy's stock could certainly be a bargain if the company's plan proves to be a success.

3. Signet Jewelers Limited 

Rounding out my list today is Signet Jewelers (SIG -2.62%), the largest seller of affordable jewelry in the U.S. You've likely never heard the name Signet Jewelers before, but I'd wager that you recognize the brands that it owns, which include Kay Jewelers, Jared, Zales, and several regional concepts.

Signet has been struggling to move its top line in the right direction recently, which has taken its toll on the company's stock price. Shares are down more than 41% over the past year, which has caused the company's forward P/E to drop below 10. That could make shares a bargain -- if management can reignite growth.

That's unlikely to happen this year, though. Last quarter, revenue fell by 2.6%, which was driven by a huge decline in the company's Jared store concept. Same-store sales from this division fell by 7.6% year over year, with management calling out energy-dependent regions as a major source of the weakness. That caused the company to forecast negative same-store sales comps for for the full year, which is a reversal from its prior outlook of positive comps.

Despite the near-term challenges, analysts are still bullish on the company's long-term profit potential. Currently, analysts are calling for EPS growth of 12% annually over the next five years, which gives the company a low PEG ratio of 0.75. If Signet can come anywhere close to delivering on those expectations, then shares are likely to be a bargain today.

Are any worth buying?

I personally tend to shy away from buying stocks that are in turnaround mode just because they are cheap, so I'd suggests investors approach each of these stocks with caution. However, I must admit that I'm intrigued by Macy's stock right now, as I like that the management team is taking a proactive step to rightsize the business and invest in its brand before the struggling stores really become a noose around its neck. If the company can deliver on its earnings growth projections, then I could easily see shares rallying from today's price. Mix in a dividend yield of 4%, and the company's shares could easily be considered a bargain today.

Brian Feroldi has no position in any stocks mentioned. Like this article? Follow him on Twitter, where he goes by the handle @Longtermmindset, or connect with him on LinkedIn to see more articles like this.

The Motley Fool recommends Fossil. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Macy's Stock Quote
$23.14 (-2.16%) $0.51
Fossil Group Stock Quote
Fossil Group
$4.59 (-4.17%) $0.20
Signet Jewelers Stock Quote
Signet Jewelers
$62.73 (-2.62%) $-1.69

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