Markets

7 Stocks at Bargain Prices

Their shares didn't deserve to be clobbered. Jump in before the herd realizes its mistake.

By David Landis, Contributing Editor

From Kiplinger's Personal Finance magazine, June 2008

EDITOR'S NOTE: The story was posted in May, so the stock prices quoted below may have changed. Click on the stock symbols to get current prices.

Whenever investors rush to the exits, stocks of good companies tend to get trampled along with the bad. And there has been quite a stampede out of stocks since last October. Between then and mid April, Standard & Poor's 500-stock index declined 15%; at one point, the benchmark was 18% below its peak.

After sifting through the wreckage, we think we've found seven companies that don't deserve the drubbing they've gotten. All of them have obvious competitive advantages that seem to have been overlooked because of the gloomy short-term outlook in their businesses.

In spotlighting these seven, we are mindful that cheap stocks can always get cheaper. But we have narrowed our list to those that have the financial wherewithal to withstand a prolonged downturn, if it comes to that. When investors sense a recovery is on the way, these stocks' advantages will become obvious and they won't remain bargains for long. The seven are listed in order of market value, starting with the biggest.

Apple of my eye(pod)

With some 85 million iPods in circulation, is the market for Apple's franchise product tapped out? Investors seem to think so. They've pushed the shares down 27% since their late-2007 peak of $202.

But Apple devotees appear to be trading up. Although iPod sales were up just 5% in the December quarter, at 22.1 million units, iPod revenues were up 17%, to $4 billion, as buyers moved to more-expensive versions, such as the Touch, which incorporates wireless Internet browsing.

What's more, Apple expects to sell ten million iPhones this year. Although Apple tracks their sales separately, iPhones are essentially iPods with phone service. Viewed in that light, there's plenty of life left in the iPod franchise as Apple adds new capabilities. "Apple has established a whole range of digital-media products with the potential to communicate with one another," says Michael Lippert, manager of Baron iOpportunity fund, which counts Apple among its top holdings. "Who cares what the differences are in terms of labels?"

Lost in the iPod fuss is the renewed growth in sales of Apple's desktop and laptop computers. Their revenues were up 47% during the October-December quarter compared with the year-earlier period. With just a 3% share of the market for computers, Apple, based in Cupertino, Cal., has plenty of room to grow here, too.

The stock (symbol AAPL) trades for 28 times estimated calendar '08 earnings (Apple's fiscal year ends in September). But remove the company's $18.5-billion cash hoard -- equivalent to $20 a share -- from the equation, and the price-earnings ratio falls to 24.

In addition, Lippert notes that earnings are depressed by Apple's decision to count most iPhone expenses when the sale is made but stretch out recognition of the revenue over two years. Deferred iPhone revenue (including deferred AppleTV revenue) was $1.4 billion during the October-December quarter, up from $636 million the previous quarter. Apple looks even cheaper when earnings are adjusted for this accounting maneuver, Lippert says.

More than a rater

Through its ownership of bond-rating behemoth Standard & Poor's, McGraw-Hill has been dragged into the middle of the subprime-mortgage mess, and its shares (MHP) have plunged 50% since June 2007. S&P and other bond raters are under fire for vouching for the safety of complicated mortgage securities that later plummeted in value.

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