5 Undervalued Small Stocks Under $5

The first to slump and the last to rally — that’s the usual fate of stocks of smaller companies when the markets wildly gyrate. Their perceived riskiness — relative to blue chips — keeps them in the doghouse, even after the broader market posts a sustained rebound. With the S&P 500 up roughly 10% since Oct. 3, might it finally be time for investors to move a bit on out on the risk curve and focus again on low-priced small stocks? If so, it pays to look at stocks that have taken an especially hard hit in this choppy market.

Even as the S&P 500 is now higher than it was on July 22, when the market sell-off began, these five low-priced stocks are off at least 15% since then, and now look like deep bargains.

#-ad_banner-#1. Office Depot (NYSE: ODP)
Recent Price: $2.24
Price change since July 22: -38%

This office supply chain has always toiled in the shadow of industry leader Staples (Nasdaq: SPLS), posting subpar growth metrics for an extended time. You have to go back to 2006 to find the last time that sales grew at least 5%.

Yet tepid sales still haven’t prevented Office Depot from delivering respectable free cash flow: The retailer has generated a cumulative $300 million in free cash flow in the past three years, helping to boost tangible book value to $600 million. That’s right in line with the company’s market value, prompting Chairman and CEO Neil Austrian to acquire 100,000 shares with his own money in late August. He bought stock at $2.50 a share, and it’s now more than 10% below that level. Goldman Sachs, which sees shares rising from a recent $2.20 to $4, assessed results from the most recent quarter and noted that “efforts to improve profitability through better analytics and an ongoing cost-cutting effort are gaining traction.” By Goldman’s math, this stock sports a free cash flow yield (based on 2012 forecasts) of more than 20%.

2. JetBlue (Nasdaq: JBLU)
Recent Price: $4.45
Price change since July 22: -16%

This stock looks even cheaper than Office Depot on a price-to-book (P/B) basis (tangible book value stands at $1.7 billion, while the company is valued at $1.3 billion). Soaring fuel prices have crimped profits for this low-cost carrier in recent quarters, but with crude oil back down near $85, look for analysts to slowly boost profit forecasts for JetBlue. Expectations that it would earn $0.50 a share in 2012 were largely predicated on $100 oil, based on a survey of analysts’ models. Shares already look cheap at nine times that likely conservative view.

3. Wendy’s (NYSE: WEN)
Recent Price: $4.67
Price change since July 22: -15%

This fast-food purveyor was on the move before the market slumped in July. Shares had reached a two-year high earlier that month, on expectations that a sale of the lagging Arby’s division would enable management to better focus on profitability at the healthier Wendy’s chain. Around Labor Day, Wendy’s installed Emil Brolick as CEO, and he’s generally garnering favorable reviews: “He comes off as thoughtful, strategic and genuine, is clearly a student of the Restaurant industry,” note analysts at Goldman, who predict “Brolick is going to make an excellent CEO.” His plan of action appears to be a massive remodeling program for the stores to help reinforce a perception of quality. To better glean the company’s strategic direction, give the conference call a close listen when results are released on November 9.

4. Netspend Holdings (Nasdaq: NTSP)
Recent Price: $5.18
Price change since July 22: -37%

This stock had been above $8 when the market sell-off began, and by the time I wrote about it in mid-September, it had already fallen below $6. Little did I know it would have further to fall.

The investment thesis for this maker of reloadable debit cards, an alternative to traditional banking that’s targeted to the “underbanked” segment of the population, remains intact since my look at the stock a month ago, except its now even more of a bargain, at less than 10 times projected 2012 profits. The stock’s weakness is partially attributable to the growing pains often seen at young companies in a fairly new industry niche. But over time, that perception should change according to analyst at Sterne Agee: “As awareness of General Purpose Reloadable (GPR) cards increases, government and employers decrease check issuance, and more consumers are driven out of the traditional banking system, we expect the GPR card industry and NetSpend to benefit.” They predict shares will rise up to $7 during the next year.

5. Exide Technologies (Nasdaq: XIDE)
Recent Price: $4.87
Price change since July 22: -37%

The deep sell-off at this battery maker is hard to fathom. The company is quite stable, should soon benefit from falling lead prices, and has also pushed through recent price increases. When fiscal second quarter results are released on Nov. 8, look for management to focus on the cash flow potential of this business model. Now that costs are falling and battery prices are rising, look for Exide to boost profits at a steady clip. Per-share profits are expected to more than double in fiscal (March) 2012 and rise another 50% to about $1.20 in fiscal 2013. Shares trade for around four times that figure.

Risks to Consider: Earnings season is a time to reset the bar in terms of forward expectations. Companies may look to offer tepid forward guidance in light of the recent choppiness in the U.S. economy. Though these lagging stocks already reflect expectations of possibly sobering guidance, they’d be unable to rally until investors have a sense that forward results will be strengthening, not weakening. As of now, each of these five stocks is expected to boost profits in 2012. 

Action to Take –> The market need not rally in coming sessions for these stocks to move back into favor. Instead, a simply flat and “boring” market would be enough to refocus attention on what are now ultra-cheap valuations. Regardless of how these shares trade in the near term, they’re quite undervalued in the context of potential long-term growth and could deliver ample returns if you have a multi-year time frame.