Cheap stocks can get cheaper. They often do.

Unfortunately, "cheap" is a relative term. Precious few stocks that trade at low price-to-earnings ratios or below book value are real bargains. They look enticing, but they're actually value traps -- stocks that deserve the multiples for which they trade and punish the trash-pickers who buy them.

But don't take my word for it. Here are five "cheap" stocks that ensnared bargain-hunting prey:


CAPS Stars (5 max)

Price-to-Book Ratio In 2004

Return Since

Integrys Energy Group (NYSE:TEG)




Micron Technology (NYSE:MU)




Emulex (NYSE:ELX)




Arch Chemicals (NYSE:ARJ)




Redwood Trust (NYSE:RWT)




Sources: Motley Fool CAPS, Capital IQ.

Watch out!
How can you avoid value traps like these? My favorite method is borrowed from professor Aswath Damordaran. In his book Investment Fables, he 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 130,000-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 73 stocks that CAPS found hiding in the weeds, AT&T (NYSE:T) 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 April 23, 2009.

I'll admit to having my doubts about the old Bell belle. She's been a drag on the iPhone in the past. Even so, my or anyone else's personal complaints notwithstanding, there's no doubt that AT&T's position as Apple's (NASDAQ:AAPL) exclusive smartphone distributor here in the U.S. has paid off big.

And there's more to AT&T than just the iPhone, argues CAPS investor podnificent:

[N]ot a lot of people know about their Uverse offering. I've heard nothing but glowing recommendations and, with this offering, they should be able to give Comcast and others some much needed competition for the home ent space. Throw in their dominant position in wireless and landline (while dying) and you've got a recipe for success.

I'm not sure I'd go that far, but with the stock trading for less than 12 times trailing earnings and paying a 6.4% dividend yield, the gamble seems worthwhile.

But that's also just my take. Would you buy shares of AT&T at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate.

More bargain-basement Foolishness:

Want further guidance? Get 30 days of free access to the Fool's Inside Value service, which spotlights stocks that Mr. Market has put on sale. Apple is a Stock Advisor selection.

Fool contributor Tim Beyers is also a member of the Rule Breakers team. He had stock and options positions in Apple at the time of publication. Check out his portfolio holdings and Foolish writings, or connect with him on Twitter as @milehighfool. The Motley Fool is also on Twitter as @TheMotleyFool. Its disclosure policy is a bargain at any price.