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:


CAPS Stars
(out of 5)

2004 Price-to-Book

Return Since

Allied Capital (NYSE:ALD)




Weyerhaeuser (NYSE:WY)




Beazer Homes (NYSE:BZH)




Media General




Pulte Homes (NYSE:PHM)




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 140,000-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 22 stocks that CAPS found hiding in the weeds, Verizon (NYSE:VZ) intrigues me this week. The details:



Recent price


CAPS stars (5 max)


Total ratings


Percent bulls


Percent bears






% Above 52-week low


Sources: CAPS, Yahoo! Finance. Data current as of Oct. 8.

Verizon's wireless group is intriguing because it's emphasizing deals over exclusive relationships. I'll understand if that doesn't seem wise. The iPhone has been a profit booster for AT&T (NYSE:T), and Sprint Nextel should benefit from the success of Palm's Pre.

Verizon, by contrast, has broadly committed to the Android mobile operating system and expects to sign deals with several handset manufacturers in the coming weeks. AT&T apparently sees some merit in this move. According to The Wall Street Journal, this week it signed a deal with Dell (NASDAQ:DELL) to sell its Android-powered smartphone when it ships to U.S. customers.

"They're finally getting some decent smart phones! Verizon has spent a lot of $$developing their network and not enough on bringing in products that people actually want to use," wrote CAPS All-Star PlasmonPolariton earlier this week. "With the new smart phones ... I think that will change and their customers will benefit greatly from their huge network."

Agreed, but that's also just my take. Would you buy shares of Verizon at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate.

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