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Peter Weekes | August 11 2004 | The Sydney Morning Herald & The Age (subscribe)

Can't afford the big name stocks? Check the bargain basement. Experts share their picks with Peter Weekes.

The sharemarket recovery has seen blue-chip stocks get pricey. Purchasing 1000 shares in BHP would now cost you $13,200 or so. The answer? Seek out cheap shares, particularly those that are undervalued - and there are hundreds to choose from, many below $2.

"Last year was the year where smaller stocks and mid-capitalisation stocks really came into their own," says Michael Heffernan, an investment analyst and adviser at FW Holst. "There were some high-priced stocks that did well, but certainly the bulk of them tended to be the lower-priced ones."

Part of the growing attraction of lower-priced shares is psychological, Heffernan says. "Fundamentally, there is no difference in investing in a $2 or a $20 stock, but I think there is a perception that if the stock is lower in price it is easier to get from $1 to $2 than for a $20 stock to rise to $40. That's more perception more than reality," he warns.

Perceptions aside, how do you go about finding good cheap stock you can afford?

Independent private client adviser and Money columnist Geoffrey Hill says the same rules of investing apply, regardless of the share price.

"You should investigate the earnings per share - that is the most important thing," he says. "The trick for investors is to find companies whose earnings are growing and [whose] price-to-earnings ratio [P/E] is under the average. That means the market hasn't woken up yet to its true value and it's undervalued."

The P/E can be calculated by dividing the share price by earnings per share. To get the earnings per share, divide the net annual profit by the number of fully paid shares on offer. The P/E market average for the ASX200 is about 16.

"The P/E is imperfect, but it is a ranking device that can tell you whether the company is overpriced - or underpriced - relative to the market average," says Hill.

It should also be noted that dividing the historical earnings figure into the current market price can be misleading.

Hill warns investors to be careful about the number of shares on issue in a company, as any profit must be divided equally; that is, the more shares, the lower the capital growth and or dividend.

Broker's picks
With evidence gathering that the Reserve Bank may have to raise interest rates in the near future, Angus Geddes of Fat Prophets says he has stayed away from rate-sensitive stocks.

He likes Oil Search (about $1.35), which has a strong balance sheet and is well-placed to reap the benefits of rising world oil prices.

Lihir Gold has also caught his eye. The miner is about nine months away from completing its thermal electricity plant that will cut up to $12 million from its annual energy bill, he says.

Geddes, like Heffernan, also recommends Burns Philp, Australia's largest baker, trading in the mid-70 cents range. "Burns Philp took over Goodman Fielder last year, made some divestments and strengthened their balance sheet. On that basis we think that stock is materially undervalued in a very strong stable industry," he says.

Orica spin-off Symex Holdings (about $1.40) also looks good, says Heffernan.

"All the fundamentals are there," he says. "It's in a business that will benefit from the free trade agreement and it has a good dividend policy to boot."

In the mining area, Heffernan recommends producer Consolidated Minerals and explorer Independence Group.

"Consolidated is making money and paying a fully franked dividend of about 4 per cent, which is good for a small company," he says. "It has a good growth profile from its mines at Woodie Woodie in the Pilbara [in Western Australia]."

He says if demand for steel increases in China at anything near the pace it has over the past year, Consolidated will be in the box seat.

Independence Group doesn't pay a dividend, but Heffernan says it has potential for strong capital growth, with profits predicted to "increase dramatically" this year.

With any portfolio, diversity is the key. Paul Pekish, a senior client adviser with Patersons Securities, recommends Repcol Ltd (36c).

He says from a standing start last year the company has established a significant collection centre in India and recently signed a contract with global finance giant GE Capital, offering great growth potential.

"The centre provides Repcol with a low-cost resource not equalled by any of its Australian competitors and could see them become the leading player in the Australian debt collection market," he says.

Pekish is also bullish on scaffolding hire firm PCH Group (36c). "It has a robust balance sheet, extremely high equipment utilisation rates and several opportunities upcoming for additional contracts," he says.