Stocks On Sale - securities on the market

Kiplinger's Personal Finance Magazine,  June, 2001  by Jeffrey R. Kosnett

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IT'S NOT a stock market, goes the Wall Street saw, it's a market of stocks. Want evidence? The overall market sells at about 23 times the past year's profits, which, depending on the ax you're grinding, means that stocks are either wildly overpriced or a tad undervalued. And then there's Arkansas Best. Whether it's really the "best" of anything is a value judgment we'd rather not make. But the trucking stock sure is cheap. It sells at just seven times this year's estimated earnings. Not only is the stock inexpensive on an absolute basis, it's a bargain compared with those of other truckers.

If you're the kind of investor who enjoys ransacking the clearance table, the bear market is a blessing in disguise. For you, the downturn is like being a kid in a candy store. So, with blue chips treading water and technology's ex-titans in shreds, you have lots of opportunities to scoop up discounted merchandise.

On top of that, bargain hunters should have the wind in their sails for some time to come. After long lagging investors who favor high-priced growth stocks, value investors--those who seek stocks selling for low prices relative to a company's profits, sales or other measures--are barely a year into a resurgence that could easily last a few more years. For the record, between March 10, 2000, and April 4, 2001, the highflying, technology-filled Nasdaq Composite index plunged 68% and the broader-based Standard & Poor's 500-stock index fell 21%. But the Russell 3000 Value index, a measure of the cheaper half of the 3,000 largest U.S. stocks, gained 8%.

Potential minefields

BUYING STOCKS that sell for peanuts is tricky. Lots of stocks deserve to be cheap and stay that way. There can be, as with chemical company W.R. Grace, which is now in bankruptcy proceedings, legal obligations that will consume earnings for years. Or a company's credit can be shot, as is the case with the also-ran discount chain Ames Department Stores. Its stock has crumbled because of stagnant sales and strong competition, and the company's crushing debt load makes the resumption of growth but a dream.

Yet many ultracheap stocks are compelling. And in a market that shows no mercy when a supposedly rock-solid growth company announces that it won't grow as much as the world expects, investing in companies in which the damage is already severe and in plain view is a sensible strategy.

Our search for flawed but potentially precious gems began with the value investor's favorite tool: a low price-earnings ratio. We looked, for starters, for stocks selling at less than eight times the previous year's earnings per share. We were willing to accept a higher P/E ratio, but only if it was significantly lower than the industry average. We also looked for price-to-sales ratios below 0.8--meaning a company's stock-market value is at least 20% below its annual revenues.

You can search for cheap stocks yourself on the Internet (see, for example, www.kiplinger.com or www .moneycentral.com). The hard part is determining whether a statistically cheap candidate has been tarred unfairly--or whether it deserves to be confined to the bargain basement indefinitely. Take advantage of liberalized disclosure rules. Listen online to CEOs' quarterly earnings calls, presentations at conferences and exchanges with analysts. These are announced in advance on a company's Web site. Call the company with questions. Ask officials whether they know why the stock is so battered, and what they intend to do to rectify the problems that got them into a pickle in the first place. You want to feel confident that a company isn't standing still.

Seriously cheap stocks

BELOW, WE profile seven companies that are not standing still, and whose stocks are indisputable bargains. In mid April the average P/E ratio of these stocks, based on 2001 profit estimates (courtesy of First Call/Thomson Financial), was a mere 8. Some of the stocks were as much as 65% off their 52-week highs.

These are all small to midsize companies, but each stock is followed by at least one brokerage analyst. That's important because if a company has no analyst coverage, it's harder for mutual fund managers and other institutional investors to learn about it and provide the necessary buying power to lift the shares out of obscurity.

Delivering the goods

DAVID LOEFFLER, chief financial officer for Arkansas Best (ABFS), is mystified by the fact that Arkansas Best trades at less than seven times its projected 2001 earnings of $2.61 per share (well below the P/E of its peers), despite sporting a higher net profit margin than its rivals. "If we had the same P/E as Roadway and Yellow, our stock would be worth $27," he says. Chimes in David Humphrey, Arkansas Best's head of investor relations: "If you look at our profitability numbers the past four years, you'd be perplexed, too."

To be fair, the stock has climbed from $5 in 1998 to $17 recently, but it should still have more distance to travel. One possible explanation for the low price is lingering Wall Street dismay over a clumsy debt-financed acquisition in the mid '90s that the company had trouble digesting. But Robert Olstein, manager of the Olstein Financial Alert fund, says that not only is the stock cheaper than those of its rivals, the company generates great cash flow and owns a solid balance sheet.