Value investors have a tendency to take a closer look at stocks trading below book, low profit-to-earnings ratios, 52-week lows or other valuation parameters. Such stocks are perhaps the simplest of ways to invest in an undervalued company.
They can also be one of deadliest value trap investment ideas. The appeal of investing in companies being valued at statistically-cheap parameters is the hope that over time the market catches up with the discrepancy.
On the other hand, the market is not dumb either. A company that is trading cheap could be a sign that the assets are inferior or don't have the ability to generate growing cash flows.
One way to screen potentially good cheap stocks from bad ones is to find those that are also owned by various investors, or have other sound business characteristics. EXCO Resources (XCO) is a energy company that continues to trade at an all-time low of $4.67. The balance is levered and the income statement is distorted.
But two savvy investors, Howard Marks and Wilbur Ross, are big shareholders. Ross has a history of buying beaten-up assets and reaping big gains. He did with coal, steel and now wants to do it again with gas.
Rosetta Stone (RST), the premier provider of language learning technology products. is trading at $9, nearly half of where it was a year ago. Savvy value investor Jim Roumell of Roumell Asset Management is a big bull on the stock as he sees the opportunity in the technology platform.
Conn's (CONN) is a retailer that has seen its shares slide by more than 60% as credit losses have caused the market to sour on the company. Conn's finances its customers by extending credit. As many of us know, good credit in retail boosts sales and profits. Bad credit boosts sales but shrinks cash flow. This past quarter, Conn's reported strong sales growth but worsening performance in the credit portfolio.
Conn's was a new holding for David Einhorn's Greenlight Capital this year. He believes the credit issues are overblown. But as we all know, credit problems are not something anyone takes lightly in this post financial crisis world. As it now stands, Conn's trades for 11x earnings.
Trying to invest at the bottom can be very slippery so it helps to be in good company with smart investors. Just remember that even the smartest guys in the room don't bat 1,000.