With broad market indices like the S&P 500 trading roughly 66% above their long-run averages, the search for cheap stocks to buy can seem daunting for the individual investor.
However, the search for cheap stocks-- particularly good dividend stocks-- isn't necessarily as challenging as it might initially seem. Case in point, the Dow Jones Industrial Average(DJINDICES: ^DJI)offers plenty of investment opportunitieshiding in plain sight. Let's quickly review the five cheapest stocks in the Dow today.
Finding great value stocks can be a laborious process. Image Source: Getty.
What are the five cheapest stocks in the Dow?
According to data from S&P CapIQ, the five Dow components trading at the lowest valuations -- as defined by their price-to-earnings or P/E ratios -- are megabank JP Morgan Chase (NYSE: JPM), insurance stalwart The Travelers Companies (NYSE: TRV), credit card companyAmerican Express (NYSE: AXP), tech giant Apple (NASDAQ: AAPL), and struggling IT behemoth IBM (NYSE: IBM).
Compared to the S&P 500's 25 times P/E ratio, this consortium of cheap stocks trades at multiples roughly 50% below the broad market. Here's a snapshot of each individual company's valuation.
Data source: S&P CapIQ.
Though grossly oversimplified, a host of academic researchsuggests that investors who buy cheap stocks can outperform the average market performance over the long term. This philosophy comprises the bedrock of "value investing," which was popularized by billionaire investor Warren Buffett. Perhaps it should then come as no surprise that Buffett's Berkshire Hathaway owns major stakes in three of the names appearing in the above chart: American Express, Apple, and IBM.
However, not all "cheap" stocks are created equal. Any stock can be cheap or expensive for a whole host of reasons, some positive and others quite negative. As you'll see below, investors looking to buy value stocks always need to delve into the specifics of why each company sports its relative valuation.
To further elucidate this point, let's briefly examine a name or two from the list abovethat are either opportunities to buy cheap or risky investments worth avoiding.
As a positive example, Apple's paltry 12.8 times price-to-earnings ratio makes it a legitimate value stock for investors. Though its golden decades of historic growth are long gone, Apple still has plenty going for it today. Its shares today trade at their substantial discount because of what will likely prove a cyclical lull in its iPhone business.
Apple will soon launch an updated form factor of its all-important iPhone-- likely next month. In anticipation of this, consumers have predictably held off from purchasing Apple's soon-to-be-outdated iPhone 6 models. True, Apple's iPhone 7 might prove to be a relatively unimpressive
Image source: Apple.
upgrade over its predecessor.However, given Apple's incredible customer loyalty and brand strength, it seems more likely that a disappointing iPhone 7 will simply shift iPhone purchases one year further out into the future -- when Apple will reportedly debut an impressive 10thanniversary iPhone -- rather than cause a mass exodus toward Android-based rivals like Samsung. Should this play out as described, investors willing to buy while sentiment around Apple remains muted stand to be handsomely rewarded.
On the other hand, American Express stands as a counter-example. As the result of a few industrywide trends, AmEx finds itself facing several relatively new competitive pressures.The company lost key card partnerships with Costco and Fidelity, while also facing new pressure in the credit card space from big banks and increased regulations. Its performance has predictably suffered, and its share price has underperformed the broad market by nearly 40% in the past two years.
American Express certainly isn't remaining idle in reaction. The company has enacted substantial cost cuts while also investing in new growth initiatives. However, unlike Apple, where a clear roadmap for multiple expansionis evident, American Express' path back to its longtime dominance isn't nearly as clear -- though it is certainly possible. Either way, hopefully this illustrates that investors looking to buy cheapstocks like those above should dig deeper into the particulars of each individual stock before buying.
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Andrew Tonner owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends American Express. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.