When Being Cheap Has Value

 | Jan 17, 2014 | 5:00 PM EST
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There's often a Catch-22 in investing: Cheap stocks are cheap for a reason. Indeed, there's something to be said for paying a higher price for a higher-quality business. I felt this way two years ago when Chipotle (CMG) shares were trading for $240 apiece and trading at 26x earnings. The quality and growth of the company's earnings justified, at least in my view, paying "up" for the business. Then again, buying those shares at 26x earnings wasn't really paying "up" because the future cash flows suggested that one was buying an undervalued asset. 

The key for investors is to understand that a cheap stock doesn't mean it's an undervalued company, just as a pricey stock does not necessarily convey an overvalued asset. Price is what you pay and value is what you get.

But you can have your cake and eat it too. Indeed, in 2009 and 2010, it was a feast for investors in terms of being spoiled on prices and valuation. Today, there are still pockets of quality stocks that are cheaply priced but possessing quality value.

One name that has been going through a rough patch but may now be worth keeping tabs on is Weight Watchers International (WTW). Shares were recently trading around $30, down 50% from last year. The stock price values the company at 7x earnings and on a forward basis, 10x earnings. The yield is a no longer exciting at 2.2% but it's something, nonetheless. WTW is a known brand, and the market is currently viewing the company as a dying fad, much in the same way companies like Panera Bread (PNRA) were punished years ago when the low-carb craze was the fad. We know folks want to stay fit, it's just determining whether WTW will come out stronger.

 You don't find growing tech names usually making a low price-to-earnings quality list, but Apple (AAPL) at 11.5x forward earnings seems to fit the bill. Apple definitely has serious competition from Android, and the iPhone is gradually losing market share, but the iPad remains the dominant tablet. The iPhone is still a cash cow as older models are selling like crazy in emerging markets, and Apple can still innovate.

Other high-quality names to add to this bucket include insurance company HCI Group (HCI), Motorcar Parts of America (MPAA), and big-caps like Goldman Sachs (GS), Deere & Co. (DE), and Corning (GLW). Happy hunting.

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