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Weekend Wisdom

Buying stocks under $5 is like buying a lottery ticket. It's the thrill of the "what if".

Take a stock like electronics retailer RadioShack. It's been in business for over 100 years. Shares of the stock traded over $20 as recently as 2010. In 2012, shares were still priced above $10.

But the company didn't make money in 2012 and its struggles continue in 2013.

Recently shares were trading at $3.10.

I know what you're thinking. That stock is "cheap", right?

But just because a stock is trading under $5 doesn't mean it's cheap and you should be adding it to your portfolio.

On the contrary.

"Cheap" stocks could be the ultimate fake out for your portfolio.


"Cheap" Doesn't Mean You Should Own It

Many investors think a stock trading under $5, is "cheap." In the minds of many investors, a well known retailer like RadioShack with over 4,000 stores can't simply "go away" despite what we've seen with companies like Montgomery Ward and Circuit City.

After all, you can buy A LOT of shares for $3.10.

All it needs to do is go to $6.20, and you double your money.

How much lower can it go? Why not take a chance?

It's easy to see how the gambling mentality takes over with low priced stocks.


Don't Be Fooled by Low Share Prices

Don't get sucked into only looking at the price of the stock to determine if it is a bargain. The stock price is, really, irrelevant. It's all about the earnings in conjunction with the share price.

More . . .


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For example, storage maker Western Digital appears "expensive" as the stock trades at nearly $70 a share. But analysts estimate F2013 earnings around $8.33 per share. That would give the company a forward P/E around 8.7. Now, that is cheap.

Or consider IBM. Many consider it to be an "expensive" stock simply because it is trading around $200 a share.

But if you look beyond the share price you can find IBM's true value.

IBM is expected to produce double digit earnings growth next year and it has $9.5 billion cash on hand.

It has a median forward P/E of 14 over the last 10 years but right now it is trading at just 11.7x.

Based on its fundamentals, IBM is actually quite "cheap" despite the $200 share price.


Volatile Markets Create "Cheap" Stocks

The stock market has been on a roller coaster in the last year with the uncertainty over the debt ceiling, the Eurozone debt crisis, the U.S. election and the fiscal cliff, but it has surged to new all time highs on the back of the Fed's QE plan. Several big name stocks fell under $5 during the turbulence.

Just because a stock is low priced, doesn't mean it's a value stock. Far from it. Buy earnings, not share price.

Look at price-to-earnings ratios and other value fundamentals first. Use the Zacks Rank to find companies with rising earnings estimates.

What will be the fate of investors who bought RadioShack at $3.10?

The stock has been volatile as the company announced it was looking to boost its balance sheet as it continues to burn through its cash.

"Cheap" or low priced doesn't always equal "value". Don't be fooled. Buy value first. Your portfolio will thank you.


Where to Find Real Value

I manage a Zacks portfolio that searches not for cheap stocks but for outstanding companies that are currently trading at least 25% to 50% below where they should be. Our mission is to signal "Buy" at just the right time - as the market begins to catch on and the stock price begins to rise.

The Value Investor. includes 22 stocks that are "on sale" right now and are likely to head a lot higher in the months and years to come.

Even more importantly, I am getting ready to pull the trigger on new recommendations, and you will have the opportunity to get aboard at the ground floor for the full ride upward. This is a value service, so I am glad to report that starting today you can receive our best value stocks for a full month at a total cost of just $1.

Find out more about the Zacks Value Investor portfolio >>

Good Investing,

Tracey

Tracey Ryniec is Zacks' Value Stock Strategist and serves as Editor in Charge of the Value Investor.

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