Finding great stocks at cheap prices is the basic investment mantra of the value investment set. With the market value of so many companies having come down dramatically in recent months, it would seem that the work of value investors has become quite a bit easier these days.
However, while the basic logic of value investing is sound, successfully executing this strategy requires doing a bit more homework than simply looking at the results of a value-based screen and buying the list blindly. As the following exercise will demonstrate, the outcome of such an approach could be quite disappointing.

IN PICTURES: Eight Ways To Survive A Market Downturn

The PE and PEG Ratios: a Good Way to Start the Value Search
Value measures, like the price to earnings ratio (P/E) and the price earnings to growth (PEG) ratio, are generally good valuation yardsticks to use when looking for value-based bargains. Normally used in tandem with expected earnings forecasts, the former can be used to measure the degree to which the market values a company on near-term earnings growth prospects, while the latter serves to measure how investors are valuing a company based on its longer-term earnings growth trend, which is also a forecast-based number.

Using the two popular measures, a quick screen was run to look for value bargains. A fairly generous dividend yield criteria above the 3% mark and a minimum market value over $5 billion was also added. The following list emerged.

Company Name Ticker Yield PE FY1 PE FY2 PEG FY2
ALLSTATE CORP ALL 3.25% 6.3 5.8 0.70
BANCO BILBAO VZ BBV 7.31% 8.4 7.8 0.52
ALLIANZ AG-ADR AZ 3.70% 9.6 5.5 0.37
BAE SYSTEMS-ADR BAESY 4.59% 8.0 7.6 0.76
data as of June 29, 2009

ADRs Offer Some Protection Against a Loss In The Dollar
Somewhat surprisingly, three of four stocks in our list turned out to be foreign companies with shares that trade on U.S. exchanges in the form of American depository receipts (ADRs). That introduces an element of exchange rate risk, as the U.S. dollar value of these ADRs is based on the conversion value of the underlying foreign shares, which trade in a currency like euros or pounds. For those concerned about a decline in the value of the U.S. dollar, this would one way to hedge against the negative effects of that. (Want to learn more about ADRs? See our tutorial on ADR Basics.)

Priced to Sell?
With above average yields, expected P/Es in the single digit range and PEG ratios well below one, these stocks do appear fundamentally attractive. However, a closer look at those "fundamentals" reveals that there are some dark clouds in this apparent silver lining.

In the case of the two property and casualty insurance companies in our list, Allstate (NYSE:ALL) and Allianz (NYSE:AG) business conditions have worsened due to the recession resulting in the industry swinging to a huge net loss during the first quarter. Competition has forced many carriers to sell coverage below cost as losses in investment portfolios backing policies have further dented policyholders' surplus. Part of this could be the fallout of ongoing struggle to turnaround industry giant AIG (NYSE:AIG)

Spanish banker Bilbao VZ (NYSE:BBV) is also facing its own struggle. Once one of the hottest economies in Europe, Spain's fall from grace has been nothing short of spectacular. A sudden real estate market collapse has led to an 18% unemployment rate and Spanish banks holding the bag on thousands of defaulted properties. BBV doesn't expect any sort of recovery until 2012.

And UK defense giant BAE Systems (PK:BAESY) is likely to see a decline in future orders as the UK government confronts the reality that it simply can't afford to continue spending on defense at the current rate. A just released study has recommended a $40 billion cut in defense spending. Recent bad optics surrounding more than $1.6 billion in cost overruns on two aircraft carriers that have been described as "Cold War relics" should also help speed the decision to make the cuts. BAE's involvement in this fiasco isn't likely to be a plus in its efforts to win new orders in future.

The Bottom Line
The market tends to price in fundamentals - good or bad. Cheap doesn't necessarily translate into value, and it pays to do your homework when scouting the bargain basement looking for value. (Learn how to find and calculate P/E and PEG ratios in our article, How To Find P/E And PEG Ratios.)

Related Articles
  1. Economics

    Is a Recession Coming?

    In the space of a week, the VIX Index, a measure of market volatility, spiked from 13, suggesting extreme complacency, to over 50, evidencing total panic.
  2. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  3. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
  4. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  5. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  6. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  8. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  9. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  10. Professionals

    What to do During a Market Correction

    The market has what? Here's what you should consider rather than panicking.
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. The New Deal

    A series of domestic programs designed to help the United States ...
  3. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  4. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  5. PT (Perseroan Terbatas)

    An acronym for Perseroan Terbatas, which is Limited Liability ...
  6. Ltd. (Limited)

    An abbreviation of "limited," Ltd. is a suffix that ...
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!