Last Friday, hordes of Americans woke at the crack of dawn (or in some cases, even earlier), quickly descending on local malls and stores to start their holiday shopping.
With many retailers concerned that the continued U.S. housing slump will crimp consumer spending, these Black Friday shoppers were met with all kinds of promotions and sales. Some stores even opened their doors as early as 4 a.m. with promises of major markdowns.
In the spirit of holiday bargain hunting, I thought it would be a good time to search for some solid companies whose stocks have been marked down quite a bit during 2007, leaving them selling at bargain-basement prices.
I checked for stocks that have dropped by more than 20% since the start of the year, but which still have the type of strong fundamentals that garner approval from my "Guru Strategies"--computer models that are each based on the philosophy of a different Wall Street great.
What I found was that the market's current bargains aren't limited to the downtrodden financial and housing arenas. Here's a look at a variety 2007 laggards that my models think are in good position to bounce back strongly.
Chico's: The retail sector hasn't been too popular lately, and the retail clothing industry is winding up a particularly rough year. Chico's is no exception; its stock has dropped about 50% in 2007. Two of my models think, however, that it is prepared to weather the current downturn.
Operating under the Chico's, White House/Black Market and Soma Intimates names, Chico's owns 982 stores in the U.S, District of Columbia, U.S. Virgin Islands and Puerto Rico, selling a variety of women's clothing, accessories and jewelry. It has a market cap of $1.8 billion.
Despite the current retail fears, Chico's has a history of producing good earnings through a variety of market conditions, one major reason that it gets high marks from my Warren Buffett-based strategy.
Special Offer: Invest like the legends--Graham, Buffett, Lynch, Zweig and others. The Validea Hot List takes the best current picks based on the strategies of the world's best investors of all time. The portfolio has returned 172% since inception in 2004, vs. a 42% gain for the S&P 500. Click here for a 30-day free trial.
Buffett likes companies that have solid, stable earnings that are continually expanding, and the model I base on his approach targets firms whose earnings per share have increased steadily throughout the past decade. In the past 10 years, Chico's EPS have risen in every year but the most recent one, increasing from $ 0.02 to $0.93 during that time, Because it has such a long history of increasing earnings, my Buffett-based model views last year's drop in EPS as a good opportunity to buy, not as a problem.
Buffett also likes companies with strong management, and one way he finds such firms is by looking at return on equity. The model I base on his approach requires companies to have average annual ROEs of at least 15% both for the last 10 years and the past three years, with annual ROEs of at least 10% in each of the past 10 years. Chico's 10-year average ROE is 25.2%, its three-year average is 23.1% and its lowest annual ROE over the past decade is 12.8%, passing all three tests.
The strategy I base on the writings of Peter Lynch is also high on Chico's. My Lynch-base model considers the retailer to be a "fast-grower"--Lynch's favorite type of investment--because of its 23.95% growth rate (based on the average of the three-, four- and five-year EPS figures).
Lynch is perhaps best known for his reliance on the price-to-earnings-growth ratio, which divides a stock's price-to-earnings ratio by its long-term growth rate to identify growth stocks that are still selling at a good price. PEG ratios below 1.0 are acceptable, with those under 0.5 the best case. With a P/E of 12.16 and that 23.95% growth rate, Chico's boasts a 0.51 PEG ratio, easily passing this test and falling just short of the best-case category.
Like Buffett, Lynch targeted conservatively financed companies, and the model I base on his writings requires a firm's debt to be equal to no more than 80% of its equity. Chico's excels here: The firm has no long-term debt, passing this test with flying colors.
Charlotte Russe Holdings: Like Chico's, Charlotte Russe is another women's retail clothier whose stock has dropped by about 50% this year but still gets approval from my Lynch-based model. Headquartered in San Diego, Charlotte operates more than 360 stores in over 40 states and Puerto Rico, catering largely to young women in their teens and early 20s. It's a small-cap ($375 million) so it's susceptible to some volatility, but it's posted several years of strong earnings.
Charlotte has been growing at a 33.07% rate (based on the average of the three-, four- and five-year EPS figures), making it a fast-grower, according to my Lynch-based model. Its P/E ratio is just 9.25, making for a strong 0.28 PEG, good enough to fall into the best-case category on this model's most important test.
In addition, Charlotte Russe, like Chico's, has no long-term debt, another reason it gets approval from my Lynch-based model.
Cascade Bancorp: Based in Oregon, Cascade is the parent of Bank of the Cascades, a community bank that has a network of 34 branches in Oregon and Idaho. Its stock has taken a major hit this year, falling more than 40%, but much of the decline appears to be due to overall fear of financials rather than any problems with Cascade. Recently, the firm actually upped its third-quarter dividend payout, citing strong results, and its fundamentals are impressive enough to get approval from both my Buffett- and Lynch-based models.
My Buffett-based strategy is high on Cascade because its EPS have increased in every year of the past decade, rising steadily from $0.25 to $1.34 during that time. In addition, the bank has posted an average return on equity of 20% over the past 10 years and 17.8% over the past three years, with its annual ROE never falling below 14.5% in any one year. That passes all three of my Buffett-based ROE tests, a sign of strong management.
Another factor Buffett considers when examining a stock is how its initial and expected yields compare with the long-term treasury yield. (Who wants to take on the risk of a stock if you can get the same kind of returns from a T-Bill?).
Currently, the long-term treasury yield is about 4.8%; Cascade's initial rate of return is 8.37% (determined by dividing its trailing 12-month EPS of $1.39 by its current market price of $16.61), a good sign. And, based on analysts' consensus long-term EPS growth rate projections, the firm's rate of return is expected to increase by 13.3% per year, another sign that the stock is a more attractive investment than treasury bonds.
My Lynch-based model, meanwhile, sees Cascade as a fast-grower because of its 24.24% growth rate (using the average of the three-, four- and five-year EPS figures). Together with its 11.93 P/E ratio, that makes for a 0.49 PEG, falling into the best-case category on this critical Lynch-based test.
Because the nature of their business involves taking on substantial debt, Lynch doesn't use the debt-to-equity ratio when looking at financial companies. Instead, he uses the equity-to-assets ratio, which measures financial health, and the return on assets rate, which measures profitability.
The model I base on his writings requires a company to have an equity-to-assets ratio of at least 5% and an ROA of at least 1%; at 12% and 1.72%, respectively, Cascade passes both tests.
Wolseley: This U.K.-based firm, which has an $8.9 billion market cap, is the world's largest specialist trade distributor of plumbing and heating products to professional contractors, and a leading supplier of building materials. It operates in 28 countries throughout the Americas and Europe.
Wolseley's stock has dropped more than 40% since the U.S. housing troubles heated up at the beginning of the summer, but the firm has a strong presence outside the U.S. and strong fundamentals, making it well-positioned to weather the current storm. It gets approval from the strategy I base on the writings of mutual fund great John Neff, as well as my James O'Shaughnessy-based method.
Neff was a bargain hunter; he targeted stocks whose P/E ratios were between 40% and 60% of the market average. Currently, Wolseley's P/E is 8.92, about 47% of the market average (19.0). That's just the kind of bargain P/E Neff looked for.
One way Neff made sure that a low P/E company wasn't simply a poorly performer was by comparing its total return to its P/E ratio. (Total return is equal to EPS growth plus yield, reflecting Neff's belief that dividends were an important part of investing.)
Total return/PE ratios that are double either the market average or the industry average pass my Neff-based model; thanks in part to its strong 6.44% dividend yield, Wolseley's total return/PE is 1.55, more than doubling the market average of 0.73 and passing this test.
O'Shaughnessy, meanwhile, targeted large companies when looking for value picks because they tend to exhibit solid and stable earnings. The model I base on his writings thus first requires firms to have market caps greater than $1 billion. Wolseley, with a cap of almost $9 billion, makes the grade.
My O'Shaughnessy-based value model also compares stocks with the market average in a number of categories. One is cash flow per share, which must be greater than the market mean. Wolseley has a cash flow per share of $2.47, exceeding the market mean of $1.59.
Another reason Wolseley scores high on this model: that excellent 6.44% dividend yield.
NBTY: While many of its companies have been posting nice profits, the health care sector has been lagging a bit in recent years, Kiplinger's David Landis noted recently, as recalls of high-profile products, a more cautious Food and Drug Administration and political pressures to control health care costs have all lingered over the sector.
One of the health care firms that has performed well but suffered in the market is New York state-based NBTY, whose stock price has dropped by about 30% this year. NBTY, which makes a variety of value-priced nutritional supplements and has a $1.9 billion market cap, gets high marks from my Lynch-based model. One big reason is that its P/E ratio (9.65) and growth rate (21.62%, based on the average of the three-, four- and five-year EPS figures) make for a strong 0.45 PEG. That falls into this method's best-case category, indicating that this fast-grower is still selling at a good price.
In addition, NBTY's debt is low--its debt-to-equity ratio is a shade under 20%, easily coming in below my Lynch-based model's 80% limit.
NBTY and the other stocks I've mentioned have all taken some major hits in the market this year. But don't be fooled by the lack of attention they've been getting from investors. Much of their declines appear to be attributable to over-reactions to problems in their industries, not to problems with the companies themselves.
While you don't need to get up at 4 a.m. to snatch them up, you'd be wise to consider adding some of these stocks to your portfolio before the rest of the market catches on to how undervalued they are.
John P. Reese is founder and CEO of Validea.com and Validea Capital Management. He is also co-author of The Market Gurus: Stock Investing Strategies You Can Use From Wall Street's Best.
© 2026