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Everyone likes getting a bargain, and investors are no exception – but finding cheap U.S. stocks that also offer huge profit potential is no easy task.
Picking stocks with low prices is not enough. Thanks to the market's May swoon and seven-for-eight losing streak earlier this month, there's no shortage of low-priced U.S. stocks in 2012. But many of those are destined to chug along forever with low prices – or go bust altogether.
At the same time, some U.S. stocks priced at $100-plus per share could be considered bargains.
The key in both cases, of course, is value.
Only by comparing a stock's price to its underlying value can you decide whether it's a "bargain."
Unfortunately, it's not quite as easy as it sounds. There are almost as many definitions of "value" as there are securities analysts.
However, most agree on the following fundamental measures of intrinsic worth:
- The stock has a low price/earnings (P/E) ratio relative to other companies in its industry segment or the market as a whole.
- The P/E ratio is below the stock's own average P/E over the past 10 years or so.
- The company's earnings history is stable – i.e., the low P/E is not due to unusual capital gains or some other one-time revenue event.
- The company's earnings have increased for the past three years on stable or rising cash flow.
- The stock is selling at a price below book value – i.e., the company's tangible assets are worth more than the value of the outstanding common stock.
- The company has little or no debt – and, if there is debt, it is rated "A" or better.
- The current low stock price is not the result of a sharp drop in operating margins, management shake-ups or some kind of financial scandal.
- In spite of its solid fundamentals, the stock price is lagging others in the same industry segment.
Five "Bargain" U.S. Stocks for 2012
Obviously, not every "bargain" will meet all those criteria, but five U.S. stocks that currently qualify as undervalued based on the above list include:
AeroVironment Inc. (Nasdaq: AVAV), recent price $24.85 – As Money Morning Defense and Technology Specialist Michael A. Robinson reported last week, one area likely to withstand looming cuts in the U.S. defense budget is aerial surveillance and weapons technology -AeroVironment's specialty. Specifically, we're talking about high-tech, remotely piloted drones, which domestic law enforcement agencies and other civilian groups are also rapidly adopting. In addition, though growth is slow, AVAV could also profit from the trend toward electric cars, for which it makes fast-charging systems. The company reported earnings of $1.36 a share on revenue of $325 million for the fiscal year ended April 20. AeroVironment projects earnings of $1.44 on revenue of $349 million in the coming year. The current P/E of 18.2 is well below defense industry averages and at historic lows relative to the company's sales, profit growth and book value. The stock is also well off its 52-week high of $34.28.
EZCORP Inc. (Nasdaq: EZPW), recent price $25.40 – As America's largest operator of pawn shops, EZCORP's business boomed during the recent recession. But the stock took a hit earlier this year as falling gold prices cut into profit margins and investors grew wary of government efforts to crack down on issuers of "payday" and other short-term, high-interest-rate loans. Such loans account for 15% of EZPW's business. In spite of that, the sluggish economy has kept store traffic growing. The company projects profits will hit $2.90 for the fiscal year ending Sept. 30, up from $2.43 a year ago, with future growth pegged at 15% annually. That gives it a forward P/E of just 8.75 – well below market averages. The stock also has plenty of room to move before approaching its 52-week high of $37.91.
Freeport-McMoRan Copper & Gold Inc. (NYSE: FCX), recent price $34.55 – The weakness in gold prices this spring also hit FCX, but the bulk of the miner and refiner's business comes from copper. Demand for copper has been steadily increasing and lately prices have been more stable. Freeport reported earnings of $1.5 billion, or $1.55 a share, for the first six months of 2012. That was down from a year ago, but above analysts' expectations, sending the stock sharply higher late last week. Even so, the P/E remains below 9.00. The stock price is well below the company's book value, which is based on proven reserves of gold, copper and molybdenum. The stock remains well off its 52-week high of $56.78, and the dividend of $1.24 – a $3.58% yield – provides a nice cushion.
GameStop Corp. (NYSE: GME), recent price $17.03 – One reason that network, cable and satellite TV systems face growing troubles is the ever-increasing popularity of online video gaming — a retail area dominated by GameStop. The company sells gaming systems, hardware and software, and has 6,683 stores on four continents. GameStop offers a variety of online games as well as numerous online commerce services that cater to gamers. GME earned $2.41 a share on revenues of $9.55 billion in the fiscal year ended Jan. 28, 2012, marking five consecutive years of growth in spite of the recession. At the current stock price, well below the 52-week high of $26.66, the P/E is just 7.07 and the 60-cent dividend yields 3.52%.
POSCO (NYSE ADR: PKX), recent price $79.60 – For those looking for international exposure as well as a bargain, South Korea's biggest steel producer qualifies. The company, produced 37.325 million metric tons of steel in 2011 and exported over a third of that. PKX saw its stock price slip as China's economy slowed, but increased demand from disaster-stricken Japan has made up for a drop in Chinese orders. POSCO is expected to report earnings of $2.15 a share for the second quarter and $8.48 for FY 2012, continuing a five-year pattern of earnings growth. That gives it a forward P/E of 9.38, very near the bottom of the steel industry. The current stock price is down from a 52-week high of $113.24 and well below analysts' average one-year projection of $101.81. The trailing dividend of $2.57 offers a yield of 3.22%.
For investors looking for value at an affordable price, these five "cheap" U.S. stocks are definitely a good starting point for your next bargain-hunting trip.
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Value Investing: Finding Undervalued Stocks