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 at 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 Book Value

Return Since





Conseco (NYSE:CNO)




Tenet Healthcare (NYSE:THC)




MGIC Investment (NYSE:MTG)




Borders Group (NYSE:BGP)




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, author of Investment Fables. In it, 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 135,000-member Motley Fool CAPS community 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 44 stocks that CAPS found hiding in the weeds, communications contractor Harris Corp. (NYSE:HRS) intrigues me this week. The details:


Harris Corp.

Recent price


CAPS stars (out of 5)


Total ratings


Percent bulls


Percent bears






% above 52-week low


Sources: CAPS, Yahoo! Finance. Data as of June 15.

Skepticism persists when it comes to putting money into defense contractors such as Boeing (NYSE:BA), especially when President Obama has already promised to cut the defense budget.

But should this same maxim apply to Harris, a communications gear maker whose equipment the military can't seem to get enough of? CAPS All-Star Babachrono isn't so sure.

"I see truck loads and truck loads of these radios show up each day over here in Afghanistan," he wrote last week. "They are the best thing we've got over here in this poor terrain that all but requires us to rely on satellite based communications versus the line-of-sight equipment that can be easily used in Iraq. Given the impending troop surge means a greater need for radios and their spare parts. Harris will be a major key player."

Babachrono also cites a manageable debt load and what he believes to be a sustainable 2.6% dividend yield. I agree, but that's just my take. What would you do? Would you buy shares of Harris at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate.

More bargain-basement Foolishness:

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Fool contributor Tim Beyers is also a member of the Rule Breakers stock-picking team. He didn't own shares in any of the companies mentioned in this article 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.