Despite the market's roaring rally over the past three months, some stocks -- including those of well-known companies -- still look cheap.
Stocks that recently traded under $15 include Sun Microsystems (JAVA, news, msgs), General Electric (GE, news, msgs) and Pfizer (PFE, news, msgs); not not surprisingly, shares of Citigroup (C, news, msgs), General Motors (GMGMQ, news, msgs) and AIG (AIG, news, msgs) can be had for less than $5.
But as many investors learned in 2008, a low share price doesn't always indicate a bargain. Often, when a company's shares have fallen off a cliff, so have its earnings.
"There are two kinds of cheap when it comes to stocks: those that deserve to be cheap and those that don't," says Bob Auer, senior portfolio manager of the Auer Growth fund. "Just because Citi used to be $30 and is now $4 doesn't mean it's a good deal. General Motors, Ford (F, news, msgs) . . . they're zombie stocks -- the walking dead -- but we haven't killed them off yet. I wouldn't touch these."
So how do you separate the deals from the duds?
If you don't have the time or the know-how required for individual stock investing, it's better to leave it to a professional or put faith in an index. But if you'd rather be the stock picker, get ready to do some digging through annual reports and 10Qs (quarterly updates companies are required to file).
Here are a few tips on how to evaluate stocks, including things to look out for:
Understand why the stock is cheap. Some cheap stocks are actually value traps, which "look cheap, but they aren't really because something is fundamentally wrong with the company," says Tim Hanson, a senior analyst at The Motley Fool. "These stocks could go down further or won't outperform the market and generally end up being disappointing."
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"You might be wowed that a stock grew 20% or 25% and think it'll get back there in 2010 or 2011," he says. "But the company might be a natural grower at 8%. You can get blindsided if you don't look further back."
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Share prices are a fine place to start, but balance sheets -- which you'll find within each quarterly report -- will give you a better picture of a company's health and growth prospects. The challenge, of course, is learning how to read balance sheets. Here's a quick primer from the SEC.
A word on quality. In shaky markets like this, quality rules. That means companies with airtight balance sheets, smart managers and plenty of cash on hand.
Larry Coats, a manager of the Oak Value (OAKVX) fund, says he's looking for businesses that have "a superior position from a competitive standpoint, a superior structure in the way they operate and no significant debt."
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A good way to get a glimpse of the company's operations, as well as its management in action, is by listening to its quarterly earnings call. You can usually find out when a company's next call is scheduled by visiting the Investor Relations section of its corporate Web site.
This teleconference, which is usually broadcast live several hours after the earnings announcement, is your chance to eavesdrop on company bigwigs discussing the quarter's financial results and filling in details not included in the earnings release. Sometimes, individual investors can call in and ask questions at the end.
If you miss the whole thing, you can find full transcripts of the calls at Seeking Alpha.
Continued: Manipulated by accounting
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