9 Cheap Stocks Taking Off Right Now: Apple is One of Them

By Meena Krishnamsetty - August 10, 2012 | Tickers: ACAS, AOL, AAPL, DFS, STX | 0 Comments

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One of the most tempting ways to pick stocks is to look for high momentum. Has the stock been going up recently? If so, then the fundamental or technical factors behind that increase in price might continue in the future, driving it up further. Of course, sometimes stock prices rise because of unusual factors- one particularly good quarter, a flurry of media attention, and so on. One criterion that can be imposed on momentum stocks to get a set of better buys is the trailing P/E ratio, which makes for a good value metric. This way investors know that the rise in the stock price will likely continue if the company can grow its earnings, since it is well priced compared to its historical earnings. And by using trailing earnings, rather than forward earnings estimates, investors can know that any hype which may be infecting the stock price is also not being caught in the value metric being used.

James O'Shaughnessy combined value and momentum investing strategies in his book What Works on Wall Street. In a 52-year back testing this strategy returned an average annual compound return of 18.3% vs. 13% for the entire market. This strategy beats the market by more than 5 percentage points. Of course, this is based on average returns and annual performance of the strategy may significantly deviate from these values. According to data from Fidelity, we compiled the list of 9 large cap stocks with a trailing P/E less than or equal to 15 which have risen by at least 50% so far in 2012:

The big name on this list is Apple Inc. (NASDAQ: AAPL), which shook off an earnings miss last month and has nearly reached its high from earlier in the year. Despite its market leadership position and its ability to make a product an instant hit merely by introducing it, Apple trades at just under 15 times its trailing earnings- rare for a company which seems to be destined for continued growth. Apple had around $117 billion in cash and cash equivalents on its balance sheet as well. Excluding this and taking into account this year’s expected growth gives the stock a PE ratio of 10. There is, of course, a risk that a growing number of competitors will chip away at Apple’s market share to the point where it struggles to tread water (read our analysis of Apple and its competition).

American Capital (NASDAQ: ACAS) is an investment firm providing private equity and debt capital. Luxor Capital took a large position in American Capital last month, joining billionaire John Paulson’s Paulson and Company (see John Paulson’s top stock picks). The stock is up nicely this year and yet still trades at less than four times trailing earnings. Sell-side analysts expect its business to decline in the near future, but it still trades at a forward P/E of 11 and well under the book value of its equity.

Credit card issuer Discover Financial Services (NYSE: DFS) has also been having a good year and is still priced in value territory after its 52% rise. The company did see negative earnings growth in its most recent quarter compared to the same period in the previous year, but matched expectations after beating them for three consecutive quarters. It is priced at only nine times current forward estimates. Columbus Circle Investors reported owning 6.5 million shares of Discover at the end of March (see other stock picks from Columbus Circle Investors).

AOL Inc (NYSE: AOL) has silenced its mocking critics by more than doubling its stock price this year, fueled by a sale of a number of its patents to Microsoft and the company’s continued reorientation away from subscription-based Internet service and towards becoming a manager of content. The patent sale has also temporarily pulled up AOL’s measured earnings, so the forward P/E multiple is actually quite high at 28 (read our coverage of AOL).

Seagate (NASDAQ: STX) is the third technology stock in this list. Seagate benefited from the increased demand and prices following the flooding disruptions to Western Digital production in Thailand. This positive effect is mostly gone now. The market undervalues the stock because of the weakening PC market. The stock earned $6.49 per share in FY 2012 and we expect it to earn $6 per share in FY2013. Its forward PE ratio is less than 6. Seagate is a very shareholder friendly company yielding almost 4%. Billionaire David Einhorn had a large position in the company (see Einhorn's top stock picks). 

Overall technology and energy stocks dominate this list. We like technology stocks over energy stocks because the upside in energy prices is limited and energy stocks may experience sharp declines if the economy slows down. Historically value and momentum stocks outperformed the market significantly. We expect them to keep delivering above market average returns over the long-run.

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