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All Contents © 2017The Kiplinger Washington Editors
By Vince Martin
| April 2017
There’s an element of danger to investing in low-priced stocks. Yes, a stock that trades at $6 can seem cheaper than a stock that trades at $60, but valuations matter, not nominal prices. Moreover, even the best cheap stocks trade in single digits for a reason — usually, some weakness has been exposed, and investors have fled in fear.
Still, for some investors, cheap stocks make sense. Particularly for people with smaller portfolios or smaller positions, single-digit share prices can be useful for portfolio sizing. They can also aid flexibility, as it’s usually easier to sell a portion of a position if that position is 1,000 shares instead of 100.
Bear in mind that position sizing was a major reason why Warren Buffett’s Berkshire Hathaway Inc. (BRK.A) created its class B shares (BRK.B).
When you’re looking for the best cheap stocks, then, you don’t want to look for “cheap” — just inexpensive. You have to sort through a lot of value traps to find the value plays, and sort through a lot of fads to find the true growth plays. That’s exactly what we’ve done today.
Here’s a look at 10 of the best cheap stocks under $10 that, while not completely risk-free, offer some amount of protection, as well as double- and even triple-digit upside.
Prices and data are from the original InvestorPlace story published on April 25, 2017. Click on ticker-symbol links in each slide for current prices and more.
This slide show is from InvestorPlace, not the Kiplinger editorial staff.
Stock price: ~$7.20
Omni-channel solutions provider PFSweb, Inc. traded above $10 for several years until a tough 2016.
The company had expected solid adjusted EBITDA growth last year. Instead, guidance was cut twice, due in large part to difficulties with a new customer. Full-year profit wound up declining 12% year-over-year, and PFSweb pulled down revenue guidance for 2017 in its Q4 report.
As a result, PFSW stock has been halved over the past year.
But even with all the bad news over the past few quarters, PFSweb simply looks too cheap. Even lowered revenue guidance still suggests 5% to 9% year-over-year sales growth in 2017 — despite PFSweb’s decision to walk away from the troublesome customer. Adjusted EBITDA is guided up at least 26% year-over-year, as margins normalize without that disruption.
And after the decline, PFSW stock looks like one of the best cheap stocks out there — not because of its $7 handle, but because of its value. At the midpoint of guidance, the stock trades at just 6.9 times EBITDA and under 0.7 times revenue on an enterprise basis — both significant discounts to other IT consulting plays.
With PFSweb a clear No. 2 to the eBay Inc. (EBAY) enterprise business, and growth still ahead, those multiples are simply too low.
Stock price: ~$8.40
I wrote last month that learning platform operator Chegg Inc. was a clear candidate for a short squeeze, but that squeeze hasn’t happened yet. CHGG stock still trades near resistance just above $8 — and still some 21% of its float remains sold short.
Chegg’s earnings are due on May 1, and that could be a catalyst for a short squeeze — and/or more organic upside. Chegg shares aren’t cheap, but the company continues to grow its user base among college and high school students. The low-margin textbook rental business has been shifted to an unrelated third party. What’s left is a high-margin platform of tutoring services, study help and e-textbook rentals with significant operating leverage and long-term network effects.
Chegg shares might be cheap on a nominal basis, but unlike PFSW, it’s far from cheap on a valuation basis; CHGG trades at more than 30 times EBITDA. However, growth stocks rarely are cheap — and as long as Chegg can keep its revenue growth going, and tantalize investors with future profits, the shorts eventually will have to change their tune.
Stock price: ~$4.15
There aren’t many retailers out there worth considering, but Sportsman’s Warehouse Holdings Inc. is one of them.
SPWH has been hit by concerns about weakness in its hunting and shooting assortment. Weakness in firearms similarly has brought down stocks of manufacturers like Vista Outdoor Inc. (VSTO), American Outdoor Brands Corp (AOBC) and Sturm Ruger & Company (RGR).
In the case of Sportsman’s Warehouse, the decline has been too severe. SPWH trades at just 7 times the midpoint of FY17 EPS guidance — a multiple given to a declining business. Yet the company’s adjusted EBITDA increased by double digits in FY16, and a guided (modest) decline in EPS this year is coming from what should be somewhat temporary weakness in hunting.
Even a more modest 10x multiple gets SPWH above $6, or more than 30% upside — even if FY17 guidance comes in toward the lower end of the range.
While investors have wisely sold a number of retail stocks, SPWH is in the cheap stocks doghouse for no good reason whatsoever.
Stock price: ~$8.90
Just a few months ago, it looked like Sprint Corp. would be off this list — for good. Sprint stock cleared $9 in January after quadrupling from February 2016 lows.
But Sprint has pulled back, providing an opportunity to investors who missed the first part of this stock’s bull run.
Sprint’s spectrum has improved its balance sheet and lowered interest, through the innovative issuance of spectrum-backed bonds. Several expert estimates suggest that Sprint’s spectrum fully supports the value of Sprint stock, leaving the operating business for free.
There are some broader concerns about the industry, with rival Verizon Communications Inc. (VZ) losing customers for the first time in its history in the quarter. But some of the lost customers went to Sprint and T-Mobile US Inc. (TMUS).
And with a Sprint-T-Mobile merger still very much in play, there are a number of paths to upside for Sprint stock.
Stock price: ~$6.20
A.H. Belo Corporation looks like a classic value trap.
The operator of the Dallas Morning News is seeing revenue and profit decline — unsurprising, given the nature of the newspaper industry at the moment.
But AHC has no debt, manageable pension expense and significant real estate assets. Its legacy headquarters building in downtown Dallas is going to be up for sale shortly, and the company’s digital businesses, while small, are growing nicely.
A.H. Belo isn’t a perfect story, and its valuation probably could be a little better. But a 5.2% dividend yield helps the stock’s attractiveness, and historically the company has paid special dividends with the proceeds from its asset sales. Should the headquarters building sell, then, another dividend could follow — and provide another boost to AHC stock.
Stock price: ~$2.00
Like A.H. Belo, Frontier Communications Corp. has secular pressures on its business. For Frontier, it’s the legacy wireline and long distance businesses that are losing subscribers and revenue. Unlike AHC, however, Frontier is a highly leveraged and highly risky play.
Even with the huge amount of debt, though, the steady decline in FTR stock of late seems a bit too much. Frontier stock now trades at its lowest levels since at least the mid-1970s.
What started the decline likely were concerns about Frontier cutting its dividend. In fact, with the dividend now yielding 22%, a cut is all but certain. However, as Morgan Stanley (MS) argued last month, a cut could probably help the stock at this point. It would free up cash to manage the balance sheet, and ease some of the selling pressure on the stock. Besides, many investors have already sold shares off in anticipation of a cut, anyway.
Again, Frontier is a high-risk play, and certainly not for dividend growth investors. But there is still value in the business — including broadband and video subscribers — while the stock is being priced for bankruptcy.
FTR is a falling knife, but if the stock can stabilize, it could rebound in a hurry.
Stock price: ~$9.35
TechTarget Inc. may not be long for this list itself. It’s in the mid-$9 range right now amid a steady (if unspectacular) uptrend since August.
Fundamentally, the stock looks sound as well. TechTarget operates websites focused on the IT industry, and then sells its subscriber base as leads to vendors such as Cisco Systems, Inc. (CSCO). But TechTarget’s reach is such that its leads are incredibly focused. Its new IT Deal Alert product actually tells manufacturers when entire departments are looking for major installations — a huge selling edge, and a valuable offering from TechTarget.
IT Deal Alert revenue grew 36% in 2016, and should drive roughly 40% of total sales in 2017, significantly boosting TechTarget’s overall growth profile. Incremental margins are extremely healthy, and there’s a case that TTGT should trade above $20 by the end of the decade if it hits the low end of management targets.
There’s even a natural acquirer in J2 Global Inc (JCOM). JCOM last year took out Everyday Health — a company with a similar model as TechTarget, albeit in consumer health rather than IT.
All told, TechTarget is one of the best cheap stocks to buy thanks to its solid but little-understood growth story. As more investors realize the opportunity, it seems likely that TTGT won’t trade under $10 for too much longer.
Stock price: ~$9.40
Pawn shop operator EZCorp Inc. is a classic “dog with fleas” stock. EZPW stock fell from $38 in 2011 to under $3 early last year, as a disastrous entry in Mexico, lower gold scrapping revenue and other missteps collapsed earnings.
Shares quadrupled last year before pulling back, and the story still isn’t perfect. There’s a controlling shareholder, which limits the possibility of an activist campaign. The strong dollar has hurt reported revenue from the company’s operations in Mexico. Gold scrapping profits remain way down. Execution still leaves a bit to be desired.
But there have been a lot of improvements as well.
EZCorp sold off its Grupo Finmart business in Mexico. Earnings jumped to 15 cents per share in Q1 from 6 cents the year before. The stock trades at a single-digit multiple to free cash flow, and has rallied after bottoming at $8 earlier this month.
An eventual sale to larger peer FirstCash Inc. (FCFS) makes sense at some point — and likely will be at a price well above $10, as long as EZCorp can continue improving.
Stock price: ~$4.00
The rally in crude has faded over the past few weeks, even as broad markets have performed reasonably well. In turn, the early-year optimism for exploration and production stocks has dimmed, with shares in the space falling as much as 30% in the past two months alone.
For contrarian investors who see strength in oil ahead, that leaves a number of cheap stocks to choose from. Chesapeake Energy Corporation (CHK) looks headed toward an eight-month low near $5. Sanchez Energy Corp (SN) has been nearly halved since early February, despite impressive production in the stacked Eagle Ford play.
The choice here is Bill Barrett Corporation.
Bill Barrett targets the Denver-Julesberg basin in eastern Colorado (and parts of neighboring states). Despite general optimism toward that play, BBG has hit a 52-week low under $4, and now trades at barely 4 times EBITDA. That’s simply too cheap a price.
A pending debt refinancing would remove convertible notes off the balance sheet, and likely extend BBG’s debt maturities. Moody’s has upgraded the company’s credit rating in response. The company is guiding for an acceleration in production in 2018, and any cooperation from the crude and natural gas markets could lead to quick and substantial margin expansion.
Just two months ago, investors seemed to believe that better drilling methods and lower costs could offset “lower for longer” crude prices. Clearly, that sentiment has shifted. But for companies like Barrett, breakeven costs are coming down. With stable oil prices, profits should come eventually. And any help from commodities should send BBG — and SN and CHK, for that matter — back up nicely.
Stock price: ~$6.10
The last of our cheap stocks is Guidance Software, Inc., which has an interesting growth story that’s been obscured by a number of external factors.
A proxy fight and patent litigation used up expense and management attention in 2016. General weakness in the security space — see the collapse at FireEye Inc. (FEYE) — has impacted valuations and investor demand across the space.
But Guidance Software appears to have found an interesting niche in forensics and so-called “eDiscovery.” That could make it an attractive tuck-in target for a larger player — particularly if its growth continues. Full-year revenue is guided up over 4% year-over-year at the midpoint, and adjusted EBITDA is projected to turn positive.
GUID isn’t cheap, trading at about 18 times EBITDA. But even modest revenue growth combined with post-restructuring savings should drive operating leverage, and make Guidance a cheap and under-the-radar growth story at just $6 per share.
This article is from Vince Martin of InvestorPlace. As of this writing, he was was long SPWH and TTGT.
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