In my opinion, too many value investors out there still mistakenly believe that a 50% slash in a stock's price means they must be getting a good deal. Recent continued declines in the "deep value" sectors have exposed the dangerous flaw in this strategy.

Single-digit P/Es and "dirt cheap" prices do not equal value. Look at former dry-bulk-shipping darlings like DryShips (NASDAQ:DRYS) and Genco Shipping (NYSE:GNK), which were cut in half between their late-2007 peak and early 2008. After a brief recovery in mid-2008, they have proceeded to decline precipitously, despite being touted by many as deep values with great dividend yields. So much for the "simply buy low P/E stocks" mantra.

Investors who bought DryShips after the initial 50%-off sale have proceeded to lose an additional 90% of their investment, assuming they've held on thus far. Our Motley Fool CAPS screener could have helped you avoid making such a mistake. Despite its unquestionable "hotness" in 2007, DryShips has never carried an "investment-grade" rating in the minds of the CAPS community, topping out at a paltry two stars over the past two years. At best, that rating represents the upper levels of the CAPS "junk status."

Should investors thus avoid all stocks down 50% or more? Certainly not! A simple CAPS screen can winnow the true values from the value traps. I look for stocks that have declined by more than 50%, while simultaneously increasing their CAPS rating. After all, if the company is worth owning to begin with, then its rating (and attractiveness to investors) should increase as its price declines. Absent a consistent improvement in ratings, severe declines could just as easily represent deteriorating fundamentals as deep value.

Specifically, the following screen sought:

  • CAPS ratings of three to four stars on June 2, 2008, around the market's summer high
  • Recent CAPS rating of four to five stars.
  • Market cap of $500 million to $50 billion.
  • Debt/equity ratios of 20% or less.
  • Share price between 50% and 80% below the 52-week high.

Below are five names that made the cut:

Company Name

LT Debt-to-Equity Ratio

Market Capitalization

Below 12-Month High

IAC (NASDAQ:IACI)

0.02

 $2.0 billion

75.6

Morningstar (NASDAQ:MORN)

0

 $1.4 billion

64.8

Net 1 UEPS Technology (NASDAQ:UEPS)

0

 $508 million

72.5

Pediatrix Medical (NYSE:PDX)

0.19

 $1.4 billion

59.6

Western Union (NYSE:WU)

0

 $8.8 billion

57.1%

Source: Motley Fool CAPS, as of Dec. 2, 2008. LT = long term.

Of course, this screen is only a starting point in the research process. You can use the CAPS screener to narrow your choices even further.

You might not have heard some of these names before, but our All-Stars certainly have. Come and join us in Motley Fool CAPS to delve into these companies further. Our 120,000-strong (and growing) community can help you sift through the rubble in search of a few great stocks that could truly represent a 50%-off sale.

Further undiminished Foolishness:

Fool contributor Vad Yazvinski, the "Skeptical Capitalist," owns none of the other companies mentioned. Net 1 UEPS is a Rule Breakers recommendation. Western Union is an Inside Value selection. Morningstar is a Stock Advisor pick and Motley Fool holding. The Fool's disclosure policy gives 50% of 220%.