3 Cheap Stocks with Rally Potential

05/25/2011 8:00 am EST

Focus: STOCKS

Shares of these companies are undervalued according to P/E ratio, and with insiders buying shares and analysts raising estimates, investors looking for value and upside potential should take notice.

Insider executives' trading activity can often provide useful clues about the health of a company, as company management often has access to confidential information about their firm's prospects. So if insider execs are using their own cash to buy shares of their employers, investors had better pay close attention!

That said, insider executives are also normal investors, just like you and me, meaning they don't always get it right. That's why it's always a good idea to see what other investors think of a stock as well. 

To get a better perspective on the insider buys mentioned below, we analyzed each company's price- to-earnings-per-share (P/E) ratio.

The P/E ratio tells you how much investors are willing to pay for $1 of a company's earnings, so the lower the ratio, the "cheaper" the stock. By contrast, if the P/E ratio is higher than industry averages, it signals that the company is trading at a premium.

To create this list, we started with the below theoretical observation about P/E ratios. First, we assigned the P/E ratio a value of constant, "K." Starting from this assumption, it follows that there should be a linear relationship between price and earnings per share:

If P/E = K, then P = (K)(E)

In other words, if there is a mismatch between growth rates in projected earnings per share values and the stock's price, a mispricing may have occurred, thus creating an opportunity for value investors.

All of the stocks mentioned below have seen an increase in the current year EPS analyst projection over the last 30 days. For each of these stocks, the price change has lagged the change in EPS projections, indicating that these stocks may still have to price in some good news.

Of course, this approach isn't 100% accurate. There is no reason to believe that P/E should be equal to a constant at all times; it's just a simplifying assumption we're using to build a screen. But the goal here is to give you a starting point in finding potentially undervalued rally stocks.

In addition, all of these stocks have seen significant insider buying over the last six months.

NEXT: The 3 Stocks with Rally Potential Revealed

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The McClatchy Company (MNI) is in the newspaper industry. Over the last 30 days, analyst projected EPS has increased by 8.11% (from $0.37 to $0.40), while price changed by -19.83% over the last 30 days (from $3.43 to $2.75).

Over the last six months, insiders have been net buyers of 318,799 shares, which represents about 0.81% of the company's float of 39.43 million shares.

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Scientific Games Corporation (SGMS) is in the multimedia and graphics software industry. Over the last 30 days, analyst projected EPS has increased by 25% (from $0.24 to $0.30), while price changed by 5.22% over the last 30 days (from $9.19 to $9.67).

Over the last six months, insiders have been net buyers of 4,565,257 shares, which represents about 16.18% of the company's float of 28.22 million shares.

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Prospect Capital Corporation (PSEC) is in the asset management industry. Over the last 30 days, analyst projected EPS has increased by 12.75% (from $1.02 to $1.15), while price changed by -1.6% over the last 30 days (from $11.58 to $11.39).

Over the last six months, insiders have been net buyers of 128,266 shares, which represents about 0.13% of the company's float of 96.12 million shares.

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By the Staff at Kapitall.com

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