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)

2005 Price-to-Book

Return Since

Ferro (NYSE:FOE)




iStar Financial (NYSE:SFI)




Regions Financial (NYSE:RF)




Unisys (NYSE:UIS)




Krispy Kreme (NYSE:KKD)




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 42 stocks that CAPS found hiding in the weeds, water engineering services provider Tetra Tech (NASDAQ:TTEK) intrigues me this week. The details:


Tetra Tech

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 Feb. 7.

Two numbers captivate me. First, return on capital has remained steady at or above 12% over the past two-and-a-half years -- well above what higher-priced peer Shaw Group (NYSE:SHAW) earns. Second, at 16.7 times normalized earnings, Tetra Tech is trading for a multiple not seen since November 2008.

Poor short-term earnings and guidance are to blame for the discount. Last month, the company reduced its 2010 earnings guidance due to what CEO Dan Batrack in a press release said was the "slow pace of stimulus spending."

CAPS investors have mostly used the news as a buying opportunity. Of the 48 who've rated the stock since that Jan. 27 report, only three have said it would underperform. All-Star tenmiles called Tetra Tech a long-term buy at $20 per share. I agree.

How about you? Would you buy shares of Tetra Tech at today's prices? Let us know by signing up for CAPS today. It's 100% free to participate.

Want further guidance? Get 30 days of free access to the Fool's Motley Fool Inside Value service, which spotlights stocks that Mr. Market has put on sale. You can try any of our Foolish newsletter services free for 30 days.

Fool contributor Tim Beyers is also a member of the Motley Fool 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.