6 solid stocks for less than $10

By Harry Domash

Editor's note: To view the stock screen mentioned in this column, download the free MSN Money Investment Toolbox.

Thanks to the sour market, many stocks have been hammered down to ridiculous prices. The last time that I checked, more than 3,900 U.S.-based stocks were changing hands for less than $10 per share.

There's money to be made from this bunch -- if you pick the right ones.

Say you pick up a stock for $5 a share. If you're lucky, it's not unreasonable to expect it to double or even triple when the market rebounds. By contrast, it's hard to imagine scoring those kinds of gains with Apple (AAPL, news, msgs) or Google (GOOG, news, msgs), even at today's beaten-down prices. Stocks that trade near $100 a share (or for much more) just don't do that.

Here's the bad news: This is not like shooting fish in a barrel. Many cheap stocks have fundamental problems and won't recover much, no matter how strong the rebound.

I've set up a screen designed to pinpoint cheap stocks likely to outperform when the market rebounds. The screen focuses on growth stocks -- that is, stocks expected to grow sales and earnings faster than most. Studies have found that, long term, share prices usually track sales and earnings. Thus stocks that record strong growth in those categories typically do the best.

Here are the details:

Go cheap -- but not too cheap

Considering the potential rewards of buying cheap stocks, I set my maximum trading price at $9.99 per share.

The downside of a cheap-stock strategy is that the lower the price, the higher the risk. My worst losses have come from stocks trading below $5 a share. Consequently, I'm ruling out stocks trading below that figure. Because I picked $5 arbitrarily, consider lowering you minimum to $4 if you want to see more stocks.

Screening parameter: Last Price <=9.99

Screening parameter: Last Price >=5.00

Active stocks

For a variety of reasons, lightly traded stocks are riskier than more heavily traded stocks. Most stocks trade hundreds of thousands of shares daily, but small stocks that don't generate much interest from Wall Street analysts often trade less.

I require a minimum 50,000 shares changing hands on an average day over the past three months. Increase your minimum to 100,000 if you want to reduce your risk.

Screening parameter: Avg. Daily Vol. Last Qtr. >= 50,000

Debt: Less is better

With the credit markets in tough shape, otherwise fundamentally solid companies are running into problems trying to refinance expiring debt. It's best to focus on no-debt stocks.

The debt-to-equity ratio, which compares total debt with shareholders' equity (also known as book value), is a widely used debt measure. Zero ratios signal no debt; the higher the ratio, the higher the debt. While no debt is ideal, I set my maximum allowable D/E at 0.1 so that I don't preclude stocks with incidental debt such as long-term lease obligations.

Screening parameter: Debt to Equity Ratio <= 0.1

Whether you're in a strong market or weak market, looking for growth, value or dividend stocks, profitable companies are always your best bets. We'll check that next.

Profitable

Profitability ratios compare a company's income with gauges of shareholders' investments required to produce that profit.

For this screen, I'll use return on invested capital, or ROIC, which measures the return you would receive on your total investment had you bought the whole company and paid off its debt.

• Video: Bargain hunting in a down market

ROIC also tells you whether a company can profitably employ borrowed funds. For instance, if it could borrow at 7%, a company earning 10% ROIC could come out with a 3% (10% minus 7%) return on the borrowed funds. However, a company earning only 5% ROIC would pay more to service its debt than it would earn on the borrowed funds.

I set my minimum allowable return on invested capital at 10%. Try lowering the minimum to 8% or 9% if you want to see more stocks.

Screening parameter: Return on Invested Capital >= 10

Valuation

Valuation ratios compare a stock's current share price with a measure of value. The price-to-earnings ratio, which compares the current share price with the last 12 months' per-share earnings, is the most widely followed valuation gauge. However, because many companies' earnings are depressed, the P/E ratio isn't useful in times like this.

Another ratio, price-to-sales (the recent share price divided by 12 months' per-share sales), is better suited to current conditions because, in most cases, sales have dropped only modestly compared with earnings.

In normal markets, price-sales ratios for growth stocks typically range between 5 and 9, and sometimes much higher. Now, however, many solid growth stocks are trading with price-sales ratios below 3.

Consequently, I set my maximum allowable price-sales ratio at 3. Try cutting that number to 2 if you want to reduce your risk or increasing it to 4 if you don't mind higher risk and want to see more stocks.

Screening parameter: Price/Sales Ratio <= 3

Continued: Growth counts

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