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 Ratio

Return Since

Genworth Financial (NYSE:GNW)




Semiconductor Manufacturing International (NYSE:SMI)








Furniture Brands International (NYSE:FBN)




American Axle & Manufacturing (NYSE:AXL)




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 145,000-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 19 stocks that CAPS found hiding in the weeds, infrastructure services firm Cloud Peak Energy (NYSE:CLD) intrigues me this week. The details:


Cloud Peak Energy

Recent price


CAPS stars (out of 5)


Total ratings


Percent bulls


Percent bears






% above 52-week low


Sources: CAPS, Yahoo! Finance. Data current as of Dec. 24.
* Cloud Peak Energy began trading on Nov. 20.

Once more, I'm turning to my Foolish colleague Christopher Barker for a stock idea. Here's what he had to say about Cloud Peak Energy shortly after its November IPO:

Essentially, Rio Tinto (NYSE:RTP) has just sold a 52% stake in producing [Powder River Basin] coal mines to you -- the public -- for about a third less than Arch Coal paid for similar assets earlier in the year.

The stock has gained some since, but still trades for less than two times book value, and this for a company that's positioned to take advantage of export demand from Asia.

Interestingly, analysts don't have much to say about the long-term opportunity for Cloud Peak. Only one equity researcher is covering the company at present.

Color me thrilled. History shows that underfollowed small-cap stocks are very often some of the best the market has to offer. Chris' research makes me wonder if that's what we have here, too.

But that's my take. What would you do? Would you buy shares of Cloud Peak Energy 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. Tim 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.