Cheap stocks can get cheaper. They often do.

Unfortunately, "cheap" is a relative term. Precious few stocks that trade for low price-to-earnings ratios or below book value are real bargains. They look enticing but are instead value traps -- stocks that deserve the multiples for which they trade and punish the garbage-grabbers who buy them.

But don't take my word for it. Here are five "cheap" stocks that trapped bargain-hunting prey:

Company

CAPS Stars
(out of 5)

Book Value,
6/22/2004

Price Change
Since

Human Genome Sciences (Nasdaq: HGSI)

***

1.69

(76.9%)

R.R. Donnelley & Sons (NYSE: RRD)

**

1.91

(64%)

Hitachi (NYSE: HIT)

**

1.11

(57.5%)

Semiconductor Manufacturing Int'l (NYSE: SMI)

*

0.04

(76.7%)

La-Z-Boy (NYSE: LZB)

*

1.89

(78.7%)

Sources: Motley Fool CAPS, Capital IQ, Yahoo! Finance.

Watch out!
How can you avoid value traps like these? My favorite method is borrowed from professor Aswath Damordaran, author of Investment Fables. In it, he counsels investors to measure low price-to-book stocks by their returns on equity (ROE).

Makes sense to me. Book value is shorthand for equity. A low price-to-book stock is priced as if management won't produce high returns from the equity capital afforded it. Find a stock that defies this maxim -- a stock with an above average and rising ROE -- and you may have found a bargain.

A machete for when you're in the weeds
Our 135,000-member-strong Motley Fool CAPS database is a great place to start your search. I ran a screen for well-respected stocks trading for less than twice book value and whose returns on equity were 10% or more. I qualified it by also limiting the screen to stocks trading no more than 25% above their 52-week low, leaving plenty of room for further gains.

Of the 52 stocks that CAPS found hiding in the weeds, France Telecom (NYSE: FTE) intrigues me this week. The details:

Metric

France Telecom

Recent price Continued...