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Traders speak on telephones while working on the floor of the New York Stock Exchange. (Lucas Jackson/Reuters)
Traders speak on telephones while working on the floor of the New York Stock Exchange. (Lucas Jackson/Reuters)

TheStreet

10 cheapest U.S. stocks with best growth potential Add to ...

Warren Buffett has been known to compare human emotions and behavioural tendencies in the stock market to a simple concept: hamburger prices.

Buffett, the most well-known value investor of all time, is usually amazed when stock prices fall so low: "When hamburgers go down in price, we sing the 'Hallelujah' chorus in the Buffett household. When hamburgers go up, we weep. For most people, it's the same way with everything in life they will be buying - except stocks. When stocks go down and you can get more for your money, people don't like them anymore."

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In a recent story, I noted there could be opportunities, given the sour sentiment and drop in the stock market over the past several weeks. Although stocks have risen over the past few days, investors can still find cheap "hamburgers" if they look hard enough.

I used TheStreet Ratings' quantitative equity model and picked the highest-rated companies that have underperformed their industries over the past three months (by at least 7 per cent).

I also looked for companies that ranked in the top two quintiles (the lower, the better) of PEG ratio (price-to-earnings divided by expected earnings-per-share growth) within their sector. That would highlight companies that are undervalued relative to their peers.

So here are the highest-rated stocks for each of the 10 sectors, with returns as of June 20.

1. Alliance Holding is a diversified coal producer with mining operations in Kentucky, Indiana, Illinois, West Virginia and Maryland.

The stock has slumped 18 per cent in the past three months due to a secondary offering of 2.75 million shares, which was released in April for $52 a share. Shares are now trading $6 below the offering price.

Management has stepped up and put its own money to work with CEO Joe Craft buying $3-million worth of stock last week. The company pays a dividend of $2.22 (U.S.) a share, with a yield of 5 per cent. Alliance trades at a discount to other coal competitors at a P/E of 15. With expectations calling for 20 per cent growth, the shares look attractive. TheStreet Ratings has a $61 price target on Alliance.

2. Compass Minerals International is a provider of highway de-icing salt and specialty fertilizer. The salt segment for Compass currently comprises about 80 per cent of the overall business and is stable, yet slow-growing. The specialty potash segment (20 per cent of sales) produces sulfate of potash (SOP), which is used primarily as a specialty fertilizer for vegetables, fruits, tea, tobacco and grass. The SOP business has much better upside and should fuel growth for the company.

With margins expected to improve in 2011 and management investing to take advantage of improved potash pricing, the stock looks like a solid investment. TheStreet Ratings has a $115 price target on Compass Minerals.

3. AeroVironment sells unmanned, remote-control military aircraft and rapid-charging battery stations for electric vehicles.

The stock has fallen due to concerns over U.S. defense budget cuts. According to Benchmark Research, the company should do well because of growth in its electric-vehicle-charging business. "We will see major deployment of electric-vehicle-charging infrastructure in the coming year to support multiple electric-vehicle introductions and the White House's target of 1 million EV by 2015."

AeroVironment was recently named to a list of stocks by Goldman Sachs that have a 15 per cent probability, or better, of being acquired. Shares of AeroVironment rocketed 20 per cent Wednesday as quarterly earnings exceeded analysts' estimates. While the shares are not quite as attractive compared with when I first ran the screen June 20, they still have upside potential, given TheStreet Ratings $38 price target.

4. Rent-A-Center , the largest rent-to-own operator in the U.S., rents furniture and electronics to low- to middle-income customers.

The company has struggled in the past three months, underperforming its closest competitor, Aaron's Rents, by over 25 per cent. While Aaron's has executed flawlessly, Rent-A-Center has not, as the company missed earnings estimates. Management blamed the first-quarter fallout on poor weather conditions in February and limited availability of refund-anticipation loans for consumers. Despite the hiccup, management has stuck to its 2011 guidance of $2.90 to $3.10 in EPS, equating to revenue growth of 5 per cent to 7 per cent and earnings-per-share growth of 3 per cent to 10 per cent.

Key initiatives to boost growth, such as RAC Acceptance (kiosks in third-party stores that arrange rent-to-own programs) are in place. Management has done a good job of managing its debt position and recently boosted the dividend by 167 per cent (now at a 2.2 per cent yield). If management can achieve $3 in EPS for the full year, the stock looks cheap, trading at just 9.7 times earnings (a discount to 15 times P/E for Aaron's). TheStreet Ratings has a $41 price target on shares of Rent-A-Center.

5. Whole Foods Market has turned in a lackluster performance over the past three months, with the shares down 6 per cent, trailing the food-and-staples industry by over 7 per cent. Investors, concerned about the sluggish economy, have avoided the company.

But the news has been good, as the company issued a bright outlook for the remainder of 2011. At first glance, the shares don't look cheap. Based on the expectations from management for $1.87-$1.90 EPS for 2011, the stock trades at a P/E multiple of roughly 32 times 2011 earnings. But Bank of America-Merrill Lynch analysts argue the stock looks attractive and maintain a $68 price target.

"We believe WFM's valuation is attractive given its strategy to improve its competitive price position and enhance its cost discipline, which broadens its growth prospects and supports an outlook for improving returns while lowering the company's operating risk profile," Merrill analysts say.

TheStreet Ratings has a slightly more optimistic $77 price target on shares of Whole Foods Markets. Note that the shares jumped $4 on Tuesday, based on upbeat comments from the company's CEO, who said the natural-foods grocer is gaining market share and he is "feeling pretty bullish" about Whole Foods' future. Despite the gain, I would still consider an investment.

6. Mediware Information Systems , which has a market value of $88-million, sells blood- and biologics-management products and services to hospitals, surgery centers and other health-care facilities. The stock is down nearly 13 per cent in the past three months, but the company has released little news. The stock is thinly traded, with only 17,000 shares of average daily volume, and with only 8 million shares outstanding, it doesn't take much to move the needle.

Despite the drop in price, management reported impressive results in the most recent quarter, with revenue and earnings up 7 per cent and 57 per cent, respectively, from a year earlier. Mediware should continue to benefit from government stimulus money earmarked to improve health-care technology over the next few years.

CEO Kelly Mann, formerly with 3M's health-information division, has made great strides since his arrival nearly four years ago. Return on equity has improved to 10 per cent, up from the low single digits three years ago.

From a valuation standpoint, the shares look cheap, trading at just 6 times trailing EV/EBITDA and 15 times forward earnings. Plus, Mediware has no long-term debt and $30-million in cash. TheStreet Ratings has a $15 price target on Mediware.

7. Horace Mann Educators , which provides car and homeowners insurance for teachers and other educators, recently lowered its full-year profit forecast because of a spike in tornado- and storm-related disasters during April and May. Management reduced 2011 EPS guidance to $1.10-$1.30 from a previous $1.75-$1.95.

With the shares down 10 per cent over the past three months, investors might want to consider the recent dislocation as a buying opportunity. At the midrange of restated guidance, the shares are trading for 12.8 times fiscal 2011 estimates and, more importantly, at just 0.7 times book value. TheStreet Ratings has a $20 price target on Horace Mann.

8. Progress Software recently cut its outlook for the fiscal second quarter ended in May, saying execution problems at its EDS (enterprise data solutions) segment would lead to a shortfall.

Mark Schappel from Benchmark Securities (which rates Progress a "buy" with a $31 target) says the shortfall is a speed bump in the company's ongoing transformation, and not a sign of a slump in infrastructure spending.

TheStreet Ratings has a $34 price target on Progress Software.

9. Partner Communications is Israel's second-largest wireless operator, but is facing fierce competition in the industry. Recent regulatory changes in the cellular market are also a major headwind for the company. The government has implemented a massive 76 per cent cut in interconnection fees (the charges by mobile-phone operators when connecting users between networks) and lower exit penalties. The company has warned that free cash flow will likely be significantly hurt over coming quarters.

So what's there to like here? Israeli analysts at Bank Leumi believe the selloff has been overdone, saying "the market has overshot to the downside by pricing in an unreasonably pessimistic outcome to the changes in the industry."

The stock currently pays a 7.3 per cent dividend, but that could change, given the downward pressure on cash flow. Consider this a high-risk, high-reward investment. TheStreet Ratings has a $19 price target on Partner Communications.

10. Centrais Electricas Brasileiras is a Brazilian power utility and an operator of nuclear power plants.

Brazil, faced with ever-increasing power consumption, will probably shift its dependence from hydropower (currently more than 80 per cent of power) to coal and nuclear power in the future. In fact, the Brazilian government recently issued approvals for four nuclear plants in 2011. Eletrobras, which has grown revenue at an annualized 20 per cent over the past three years, should continue to benefit from increased demand. TheStreet Ratings has a $16.5 price target on Eletrobras.

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