Dirt Cheap Stocks

Seven extraordinary bargains that should emerge from the recession stronger than ever.

By David Landis, Contributing Editor

From Kiplinger's Personal Finance magazine, February 2009

With the market down about 40% over the past year, stocks are on sale. And because selling tends to be indiscriminate on days when the market goes into free fall (Standard & Poor's 500-stock index suffered daily losses of 3% or more 23 times in 2008 through December 5), plenty of stocks aren't just inexpensive -- they're dirt cheap.

Zeroing in on cheap stocks worth owning can be tricky. A low price-earnings ratio, for example, can be a trap, especially if earnings have further to fall.

Instead, we look for businesses with leading shares in their markets, and enough financial strength to survive a deep recession and perhaps even improve their competitive advantage (through acquisitions, for example). The seven stocks we've chosen meet those criteria. Plus, even after accounting for all the bad news on the horizon, their shares seem inordinately cheap.

Cash-Rich Conglomerate
Founded 154 years ago in Chicago to supply engine parts to the booming steam-locomotive industry, Crane(CR) almost immediately branched out into iron pipes, valves, steam-heating equipment and other businesses. Today the firm remains a conglomerate, making everything from aircraft brake systems to food vending machines.

Now based in Stamford, Conn., Crane has a diversified base of corporate customers and little direct exposure to consumers. Some of Crane's businesses, notably one that makes fiberglass panels for trucks and recreational vehicles (13% of sales), have seen a drastic falloff in sales this year. But its larger fluid-handling segment (43% of sales), which makes valves, pipes and fittings, has held up well. In October, the company lowered its 2008 earnings forecast to between $2.75 and $2.90 per share. The lower end of that range is 24% less than the most optimistic 2008 forecast Crane made earlier in the year. Yet its stock has fallen 70% from its 2008 peak (all prices and related ratios are through December 5).

Of course, things could get worse in 2009, particularly in the engineered-materials business, which makes those truck and RV panels. But Crane's aerospace-and-electronics segment (24% of sales), which makes brakes and other systems for the new Boeing 787, should see profitability pick up as the new aircraft goes into production and Crane's engineering costs decline. Even the engineered-materials segment, which Crane dominates with a 70% market share, should turn around eventually as aging baby-boomers warm to RVs. Meanwhile, the company is aggressively cutting costs.

Crane has plenty of cash -- $278 million -- and is on the hunt for companies to acquire (it has absorbed 15 companies since early 2003). Even after lowering its earnings forecast in October, Crane was still expected to generate $130 million in free cash flow (net income plus depreciation and noncash expenses, minus capital outlays) in 2008. In July, the company raised its dividend by 11%, to an annual rate of 80 cents. The shares currently yield 5.7%, a good indication of just how cheap they've become. Over the past decade before 2008, Crane's average dividend yield ranged from 1.2% to 1.8%.

Prosperous Builder
Analysts expect nonresidential construction to turn down sharply in the coming year, and shares of EMCOR Group (EME) are feeling the pinch. The Norwalk, Conn., company is one of the nation's largest builders and operators of electrical and mechanical systems. Emcor shares have fallen 52% in the past year and now trade for seven times estimated 2009 earnings -- well below their average P/E over the past five years of 21.

But despite the bleak construction outlook, Emcor recently raised its fourth-quarter 2008 profit forecast and issued an upbeat outlook for the first half of 2009. Its confidence stems from serving many recession-resistant customers -- such as those in health care, water treatment, government services and electric-power generation -- that should hold up well over the next year. In addition, Emcor says it gets about two-thirds of its revenues from ongoing maintenance contracts and renovation projects (which are less likely than new construction projects to be canceled as a money-saving measure). And Emcor stands to benefit from a massive infrastructure-spending program the new Obama administration is contemplating.

Things aren't entirely rosy. Emcor's $4.4-billion backlog of business at the end of the third quarter was down 5% from the previous quarter, due in large part to the suspension of two big Las Vegas casino projects. Any acceleration in the rate of cancellations would be worrisome. But the company has a good record in previous downturns. Its balance sheet includes $341 million in cash, more than enough to cover $200 million in long-term debt that matures next year.

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