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3 Stocks Under $5 Trading at Huge Discounts

Stocks in this article: CEDCTLBNPTN

Talbots

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It's been a slow road to ruin for women's apparel retailer Talbots (TLB). Shares have fallen from $25 in 2007 to $16 in 2010 all the way to a recent $2.50. At the current prices, the vultures are circling. The steady demise is the result of a series of merchandising missteps that sought to attract younger buyers. The fashion changes have been axed, and the current line-up of clothes reflects a return to more traditional roots. Still, the damage to the brand is done, and it will be a while before customers flock back to the stores in high numbers.

Acknowledging the new harsher reality, Talbots is closing more than 100 of its worst-performing stores (out of a current 580), while also expanding a set of revamped stores that evoke a French-couture environment.

>>5 Black Friday Short-Squeeze Stocks for 2011

Before any of this can happen, private-equity investors are circling while shares are so cheap. In early August, Sycamore Partners announced it had amassed a 9.9% stake in Talbots, with plans to discuss steps to unlock the stock's value with management. The stock temporarily rebounded $4 before pulling back again. That pullback may be due to a "poison pill" provision that makes it harder for anyone to pull off a hostile takeover. At this point, it's not clear if an outright sale will take place, or management simply stays the course and rebuilds the tattered reputation.

How cheap is this stock? Talbots earned nearly $2 a share every year back in the first half of the last decade. Assume peak earnings power will only rebound to half that level, and this still trades for less than three times potential profits.

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The key to owing retail stocks is finding business models that have stumbled that aren't broken. Pier One Imports (PIR) struggled mightily in 2008, and its shares fell to 10 cents in early 2009 before management implemented a back-to-basics turnaround strategy. Shares have rebounded all the way to $13. Teen-focused retailer Aeropostale (ARO) saw its shares plunge below $10 in September, but a modest upturn in business trends has quickly boosted the stock back to $17. It's still unclear if Talbots will experience a similar renaissance, but the potential upside for these turnaround retail plays is simply too large to ignore.

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