Really Cheap Stocks Set to Rebound, Fund Managers Say

The cheap stocks have proved rewarding. During the past five years, the Aegis fund returned 5.9% annually, outdoing 95% of small value funds, according to Morningstar.

Barbee starts by screening for small-cap stocks that sell for less than book value. Before the financial crisis unfolded, about 120 names qualified for his list. But now there are 360 candidates, since investors remain wary of deep-value stocks.

Barbee aims to find unloved companies with decent cash flows. After buying, he typically holds for several years, waiting for the stocks to rebound. Most often Barbee is right, but he can take shareholders on a rough ride. In the turmoil of 2008, the fund lost 51.4%. Aegis bounced back sharply in 2009, returning 91.4% and outpacing 99% of peers for the year. "During the financial crisis, most of our holdings continued to have stable businesses, but the stocks fell because shareholders were liquidating their portfolios," he says.

A holding Barbee likes is American Greetings (AM), a maker of greeting cards. The shares have been dropping because investors worry that traditional cards will be replaced by electronic messages. But Barbee argues that demand for the company's wares will remain solid. "If somebody's father dies, it is tacky to just send an e-mail," he says.

He also likes Aircastle (AYR), which leases aircraft to airlines. The stock trades for about half the value of the aircraft that the company owns, says Barbee.

Another strong-performing fund is Hotchkis and Wiley Value Opportunities. The portfolio has a P/E ratio of 7. During the past five years, the fund returned 8.2% annually, outdoing 98% of mid-cap value funds. Portfolio manager David Green looks for depressed stocks that have predictable cash flows. He scored big gains with Tree.com (TREE), the operator of online mortgage company LendingTree.com. Green began buying in May 2009, and he sold after the stock soared. "During the financial crisis, people thought no one would ever get a mortgage again, but we thought that the business was just cyclically depressed," he says.

The fund has scored big gains in the past year with unloved financial stocks. Current holdings include American International Group (AIG) and Citigroup (C).

AllianceBernstein Discovery Value holds a mix of mid-cap and small stocks. The portfolio has a P/E of 11. During the past five years, the fund returned 4.3% annually, outdoing 81% of mid-cap value funds. The portfolio managers are keen on technology companies. "In the current environment, you can find beaten-down stocks with very strong balance sheets," says portfolio manager James MacGregor.

A holding is Amdocs (DOX), a business software provider. The stock has a forward P/E of 10 and a big stash of cash.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.

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