With all of the recent volatility in the market, which stocks are outrageously cheap?

I found one recently, and I got to thinking about the others out there when I read money manager Bill Miller's comment that "the market abounds with good value." Of course, Miller also wrote last August that stocks were the cheapest they'd been since 1991 ... and after a brief rebound, they've gone right on dropping. Miller's fund has suffered thanks to core holdings in some recently deceptively cheap stocks such as Capital One (NYSE: COF) and Bank of America.

Given wary financial markets, a recent rash of writedowns, and a slowing economy, it should be clear that not all stocks that look cheap are cheap (with no disrespect intended to the talented Miller). Both Warren Buffett and John Hussman have recently affirmed that lesson.

There are, however, some individual stocks today that, for one reason or another, not only present "good value" but are outrageously cheap.

Back up the truck, people
What makes for an outrageously cheap stock? Here's my short list:

  1. A balance sheet with lots of cash and little debt.
  2. An EV/EBITDA ratio less than 6.
  3. A business with the financial strength and strategy to survive and thrive in a down economy.
  4. No potential for massive writedowns.
  5. A stock that's been pummeled.

Of course, even amid today's unprecedented market environment, there are only a handful of large or mid-caps that meet those criteria, so if you really want to build an "outrageously cheap" portfolio, you may need to start thinking of yourself as a small-cap investor.

Welcome to the jungle
In truth, large caps attract far too much investor attention to ever become inefficiently priced. Pfizer (NYSE: PFE), for example, is followed by 23 sell-side analysts. If you’re going to buy the stock, you have to ask yourself: What are they missing that you aren’t? In fact, there’s only one U.S. large cap -- Dell (Nasdaq: DELL) -- that meets my outrageously cheap criteria.

You generally won't find as much interest among small caps, which is one of the reasons why -- given the criteria above -- Lufkin Industries (Nasdaq: LUFK), Natus Medical (Nasdaq: BABY), and Shoe Carnival (Nasdaq: SCVL) look outrageously cheap.



Cash on Hand

Investors Scared Because ...



$110 million

Lower energy prices threaten to decimate investment in the industry.



$68 million

Frozen capital markets have led to a decrease in hospital capital spending.

Shoe Carnival


$9 million

Worsening retail environment has hit profit margins.

Data from Capital IQ, a division of Standard and Poor's.

Yes, that last subhead was a Guns N' Roses reference
The reason we love being small-cap investors at Motley Fool Hidden Gems is because it's the one area of the market where, thanks to inefficiencies and lack of Wall Street interest, stocks can become outrageously cheap. And there's good reason to think that things will get better for all three of these stocks. Of course, in a down market like this one, that lack of efficiency can make for some gut-wrenching downside volatility.

But we're using current market conditions to recommend the market's best small companies -- stocks that should crush the market averages over the next decade or more.

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This article was first published on March 14, 2008. It has been updated.

Tim Hanson owns no shares of any company mentioned. Natus is a Motley Fool Hidden Gems recommendation. Dell is a Stock Advisor and Inside Value selection. Pfizer is both an Inside Value and Income Investor pick, as well as a Fool holding. The Fool's disclosure policy is decidedly un-outrageous.