Do you find yourself drawn to low-priced stocks? These stocks tend to be highly volatile because a minor price change can reflect a greater percentage of the total stock price. While this can mean big losses, it can also lead to big gains.

We know the volatility can be discouraging, but there are ways to manage risk when picking stocks on the low end of the price range.

One approach would be to pick potentially undervalued companies which seem to have more potential upside than upside. There are many ways to do this. For the purposes of this article, we used the Graham formula, a commonly used valuation model.


Graham number
Benjamin Graham, a former mentor of Warren Buffett and the so-called godfather of value investing, created the Graham number as a calculation for the maximum fair-value price of a stock. It is based on its earnings per share and book value per share, and stocks trading significantly below their Graham number are considered to be potentially undervalued.

The Graham number = square root of (22.5) x (TTM EPS) x (MRQ book value per share)

Business section: Investing ideas
Since the Graham number is a strict valuation, it could provide great opportunities. The list below contains stocks that are trading between $1 and $5 that are undervalued to the Graham formula. Do you think these stocks have significant upside?

List sorted alphabetically. (Click here to access free, interactive tools to analyze these ideas.)

1. Amkor Technology (NAS: AMKR) : Provides outsourced semiconductor packaging and test services in the United States and internationally. The company has a market cap of $779.18 million, most recent closing price at $4.61. Diluted TTM earnings per share at 0.36 and a MRQ book value per share value at 4.17 imply a Graham number fair value of $5.81. Based on the stock's price at $4.63, this implies a potential upside of 25.52% from current levels.

2. First Busey (NAS: BUSE) : Operates as the bank holding company for Busey Bank that provides various retail and commercial banking products and services to individual, corporate, institutional, and governmental customers in the United States. The company has a market cap of $383.77 million, most recent closing price at $4.49. Diluted TTM earnings per share at 0.28 and a MRQ book value per share value at 4.76 imply a Graham number fair value of $5.48. Based on the stock's price at $4.43, this implies a potential upside of 23.61% from current levels.

3. Cumulus Media (NAS: CMLS) : Engages in the acquisition, operation, and development of commercial radio stations in the United States. The company has a market cap of $487.6 million, most recent closing price at $3.25. Diluted TTM earnings per share at 0.46 and a MRQ book value per share value at 1.94 imply a Graham number fair value of $4.48. Based on the stock's price at $3.23, this implies a potential upside of 38.73% from current levels.

4. Harbinger Group (NYS: HRG) : Operates as the holding company that focuses on acquiring interests in companies that operate in diverse range of industries. The company has a market cap of $683.11 million, most recent closing price at $4.90. Diluted TTM earnings per share at 0.22 and a MRQ book value per share value at 6.54 imply a Graham number fair value of $5.69. Based on the stock's price at $4.9, this implies a potential upside of 16.12% from current levels.

5. Lattice Semiconductor (NAS: LSCC) : Designs, develops, manufactures, and markets programmable logic products and related software. The company has a market cap of $587.26 million, most recent closing price at $5.01. Diluted TTM earnings per share at 0.5 and a MRQ book value per share value at 3.28 imply a Graham number fair value of $6.07. Based on the stock's price at $4.96, this implies a potential upside of 22.47% from current levels.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.


 

At the time this article was published Kapitall's Kelly Haugen does not own shares in the companies mentioned above. EPS and BVPS data sourced from Yahoo! Finance, all other data sourced from Finviz. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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Ben Graham was Warren Buffett's mentor and the founder of value investing.
Buffett even named his son after Graham and calls Graham, his second greatest influence after his own father.
Anahin (www.anahin.net) gives a comprehensive analysis of the stock market - all 4000 stocks listed on the NYSE and more - using all of Ben Graham's principles.

May 12 2012 at 12:44 PM Report abuse rate up rate down Reply