Markets

The Top Bargain Stocks in the S&P 500

With the outlook for the U.S.economy in question for the rest of the year, this is a bad time to pursue high-priced growth stocks. Any hit to growth forecasts can lead to a double hit from both lowered profit forecasts and a lower target multiple on those profits. Instead, your eyes should be trained on the opposite end of the market, where low-priced stocks -- matched with steady stable businesses -- can provide a safe haven in the current storm.

Sure, these stocks have taken a hit, which is why they are now low-priced. But if you find them with low-enough profit multiples and proven, profitable business models, then you'll sleep much better at night and still be exposed to considerable upside when the market finally finds its footing.

With that in mind, I scoured the S&P 500 for the cheapest stocks out there (those with forward (2012) P/E multiples below eight). I tossed out all banking stocks (because who knows what the banking landscape would look like in arecession ) and limited the list to companies that have never reported an operating loss in the past three years. If these companies could generate positive operating profits during the downturn of 2008-2009, then they're battle-tested for any challenges that may come in the next year as well.

-- David Sterman

There are some familiar names on the list. I've recently suggested RadioShack (NYSE: RSH ) , which is consistently profitable in good times and bad, deserves a fresh look. The retailer recently joined forces with wireless service provide Verizon (NYSE: VZ ) , which should give sales and cash flow a solid boost. Yet since the news was released,shares have been pummeled anew in this brutal market.

In a similar vein, I recently concludedNewell Rubbermaid (NYSE: NWL ) would hold great appeal to major investors such as Carl Icahn who are on the prowl for companies that generate prodigious cash flow. A 10% pullback in the past two weeks makes that stock that much more appealing.

In addition, I also noted that Western Digital (NYSE: WDC ) , which recently topped analysts' profit forecasts by 20%, was underappreciated by many investors . Shares initially popped on July 22 after those robust results came in and analysts raised their estimates, but have fallen more than 20% since then. Wondering how this maker of hard drives would fare in a weaker economy ? Per share profits have never slipped below $2 in any of the last five years.

You may recall 105-year old Xerox (NYSE: XRX ) from the era when photocopiers were the hot new office equipment item. The company did an impressive job of revamping its business model again in the 1990s, branching out into other equipment and outsourced services. Shares had bottomed out at around $5 in the early part of the 1990s, but eventually surged to $60 by the end of the decade.

The subsequent decade brought fresh chaos to Xerox, thanks to too much debt. Shares plunged right back below $5. A fresh management team righted the ship, moving the stock back up to $20 by 2007, and then Xerox experienced another brush with death, falling below $5 once again in 2009.

CEO Ursula Burns (the first African-American woman to head aFortune 500 company) took the reins in 2009 and sought to alter that boom-and-bust dynamic, spending a hefty $6.4 billion to acquire Affiliated Computer Services (ACS) in early 2010, a leading provider of outsourced services. It's a business with low growth prospects, but very steady cash flow thanks to long-term contracts.

Theacquisition is already paying off. Xerox generated almost $2 billion infree cash flow in 2010 and looks set to top that in 2011. Analysts think the 2010 deal was a game-changer. Xerox's customer base was largely blue-chip companies, while ACS brought a customer base of mid-sized businesses.

Bringing the firms together hasn't yet boosted sales in this tough economy. But operating efficiencies are helping to sustain quarterlyoperating income above $500 million. As a result, Xerox looks set to deliver roughly $1.10 a share inearnings per share ( EPS ) this year, up more than 15% from a year ago. Analysts at Brean Murray anticipate further cost-savings, and when you toss in a reduced share count from ongoing stock buybacks, they think per share profits may top $1.30 next year. And that forecast assumes a still-weak economy.

Despite a solid second quarter posted on July 22, shares have actually fallen more than 15% since then and are right back at the 52-week low. Brean Murray's target price of $14 is roughly 65% above the current $8.40 share price. Goldman Sachs has a modest $12price target , with projections of free cash flow of $1.89 a share in 2012, implying an eye-popping 20% free cash flow yield .

Action to Take --> The charm of the inexpensive Blue Chip stocks I mention above is that they can afford to stumble a bit in a faltering 2012 economy and still look very inexpensive. This is a nicemargin of error to have when many stocks are looking vulnerable right now. You may want to look into these names further to add significant upside with a good degree of safety to your portfolio.

P.S. -- I don't know if you're aware of this or not, but a 20-year energy agreement between the United States and Russia is about to expire. The problem is, this deal supplies 10% of America's electricity. When the Russians refuse to renew the agreement, the U.S. will face an entirely new kind of energy crisis. This disruption could send a handful of energy stocks through the roof. Keep reading…

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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