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Published: October 30, 2009
Cheap stocks aren't as plentiful as they were
seven months ago.
In some ways, of course, that's a good thing. No one likes it
when the market craters.
But even though prices have risen from their lows, that doesn't
mean investors can't find bargains out there -- they're just
tougher to spot.
Today, we'll take a look for such bargains: Undervalued
companies with the potential for big gains -- and the added
benefit of a rich dividend yield.
The first yardstick is price-to-earnings growth ratio, which is
sometimes shortened to "PEG." This measurement helps evaluate
companies to determine which are cheap relative to earnings and
expected growth.
PEG is calculated by dividing the price-to-earnings ratio and
dividing it by projected annual earnings growth (expressed as a
whole number). If a company with a P/E of 20 is project to see
earnings growth of 10%, the PEG is 2.0.
Higher PEGs typically indicate a stock is overvalued; lower PEGs
may mean the company is undervalued. I sought stocks with a PEG
of less than 1.5. This resulted in 1,198 matches.
To narrow the field, I screened out companies with high
price-to-sales ratios. The P/S ratio is calculated by dividing
the stock price it by trailing 12-month revenue per share. This
metric helps investors understand the value of stock relative to
revenue. Here again, lower values can indicate undervaluation.
And while the picture this ratio paints can be incomplete, cheap
revenue is better than pricey revenue. To find a discount,
investors should pay less than $1 for every $1 in revenue. In
this screen, I eliminated stocks with a P/S higher than 1.
This left us with 535 candidates.
The earnings multiple or P/E ratio,
if you prefer, needs no lengthy
explanation. It's simply the current
share price divided by the company's
trailing 12-month earnings per
share. In a value-oriented screen,
lower is better. I eliminated
companies selling for more than 15
times earnings, which whittled the
screen to 323 potential investments.
Next I took a look the price-to-book
ratio. Calculated as the share price
divided by net assets, this ratio
shows what a company is worth if
broken up into its tangible parts. A
P/B ratio of 1.0 means that the
company's net assets are worth
exactly what you're paying for them.
(This values the actual business at
zero.) Higher P/B values, that is,
greater than 1.0, assign a dollar
value to the company's underlying
business. Most companies trade at a
multiple to "book value." Anything
less than 1.0 means you're buying
the assets on sale and getting the
business for free. For this screen,
I used a P/B of 2.0 to weed out
expensive companies. This left 228
matches.
Price-to-free cash flow, sometimes
painfully shortened to P/FCF,
compares a company's market cap with
the amount of free cash it
generates.
If a $100 million company has $5
million in free cash flow, for
example, it would have a P/FCF of
20.
With this metric, higher numbers
indicate the company's free cash is
relatively more expensive. In a
value screen, of course, we're not
looking for anything expensive. I
used the value 10 to remove the
pricier stocks from the list, which,
after applying our criteria so far,
still had 143 companies.
Only two of those companies yield
more than 6%.
Even better, they actually pay much
more.
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-- Anthony Haddad
Staff Writer
StreetAuthority |
