Now is a fantastic time to be a value investor, and it's an even better time to be a growth investor. Financial giants such as Buffett, Greenblatt, and Fisher did well buying growing companies for rock-bottom prices. These guys weren't just buying outrageously cheap stocks -- they bought growth potential for pennies on the dollar.

But how do you find them?
My favorite method for finding cheap growth stocks involves the PEG ratio. This metric tells you how much you are paying for the expected long-term growth. If a company has a PEG of 1, then for each point of growth, you're paying one times earnings. But if growth expectations are higher than the P/E, the PEG dips below 1, giving you more bang for your buck.

Now, the fun part
With that said, here are five cheap stocks with great growth potential that also earn positive ratings from our 170,000-plus-member Motley Fool CAPS community.

These stocks have:

  • P/Es less than 20.
  • PEGs less than 0.8.
  • Positive ratings (three, four, or five out of five stars) from our community of investors.


Forward P/E



A-Power Energy Generation Systems (Nasdaq: APWR) 8.6 0.4 ****
Chimera Investment (NYSE: CIM) 5.9 0.7 ****
DryShips (Nasdaq: DRYS) 4.8 0.2 ***
Power-One (Nasdaq: PWER) 8.5 0.3 ***
SmartHeat (Nasdaq: HEAT) 6.7 0.3 ****

Data from Motley Fool CAPS and Zacks Investment Research.

Power generation
A-Power and SmartHeat go after different parts of the Chinese power generation market. A-Power builds power plants, and it's recently decided to enter the wind-turbine business. Its recent weak earnings report has given investors the opportunity to buy in at a lower price. SmartHeat sells heat exchangers in China, making power plants more energy-efficient. Analysts expect both companies to grow at an annual rate of 20% or more over the next five years, and at these prices, the risk-reward trade-off looks attractive.

A tip of the CAPS 
Each week, I cull a top stock idea from the pitches made on CAPS. Power-One was a pick in November. To follow my weekly picks, you can subscribe to the series' RSS feed or follow it on Twitter.

Mortgage REITs
Chimera is one of the market's highest-yielding stocks. Both Chimera and its former parent company Annaly Capital Management (NYSE: NLY), which spun off Chimera shares in 2007, are REITs that own securitized mortgages. They profit by borrowing money at low rates, then investing in mortgages that pay higher rates. While some investors believe Annaly is a safer play than Chimera on the mortgage market, either gives you exposure to this lucrative market.

Shipper or driller?
From its name, you would assume that DryShips primarily operates, well, dry ships. It does, but recently DryShips generated more revenue from its ultra-deepwater drillships than it did from its dry bulk business. SeaDrill (Nasdaq: SDRL) and other drilling stocks have performed well the past year as demand for their rigs has risen. Yet continued share issuance has watered down DryShips' stock. Still, investors can look forward to a potential IPO of its drilling subsidiary at some point. In the meantime, investors need to hope the company doesn't further dilute their holdings.

Finding value in growth stocks
Are these beaten-down growers worth a look, or are their growth prospects illusory? Join our Motley Fool CAPS community to get more analysis on the above ideas, create your own list of undervalued growers, or even weigh in with your own expert opinion.

If you're looking for some other ideas for strong outperformers in the year ahead, The Motley Fool has created a new free report called "The Motley Fool's Top Stock for 2011." In it, we reveal the little company set to profit from the broadband Internet expansion. Get instant access by clicking here -- it's free.

The Fool owns shares of Annaly Capital Management and Power-One. Try any of our Foolish newsletter services free for 30 days.

Dan Dzombak's musings and articles he finds interesting can be found on his Twitter account: @DanDzombak. He does not own shares in any of the companies mentioned in this article. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.