6 Cheap Stocks With Healthy Yields

In searching for stocks, I’m mildly biased against giant companies. Small and medium-size companies produce slightly better stock returns over long time periods, studies show. I’m also mildly biased against conglomerates. The label itself means a company’s divisions are so mismatched that market-data providers can’t come up with a way to categorize it. And I’m seriously biased against nonfinancial companies with large finance divisions. How is an investor to properly diversify when so many companies act like banks?

Needless to say, I’ve never recommended shares of General Electric (GE). It’s a giant conglomerate for which commercial finance made up 21% of profits last year. Personal financial services accounted for 15%. My usual advice to someone asking whether they should buy GE: If you like a broad scattering of businesses with just-OK growth prospects, you'll love an S&P 500 index fund.

But shares of GE have plunged 55% over the past year. That’s the sort of beating that has been reserved for pure banks, not engineers. Shares now go for nine times forecast 2008 earnings. That’s a discount of about a quarter from that S&P 500 index fund.

There’s more to like. GE’s dividend yield of 6.1% is more than two percentage points above the broad market’s yield. Management says it won’t cut payments at least through 2009. GE should have plenty of money to make good on that promise, thanks to recent share offerings. Past stock purchasers saw the value of their holdings diluted, but those who haven’t bought yet are looking at a sturdier company. And renowned value investor Warren Buffett recently bought a stake.

Also, GE turned up on a recent screen I ran for safe, cheap companies. I looked for healthy dividend yields and low price/free-cash-flow ratios. The latter is a sign that a company is both financially strong and cheap. I made sure my screen survivors had displayed limited trading volatility in recent years. Finally, I looked for above-average returns on equity, a hallmark of companies that know how to operate lean.

All that said, I’m not quite convinced. GE’s low P/E might mislead. Whether it is low enough depends on which way the “E” is headed, and right now earnings are seen falling 9% next year after an anticipated 11% drop this year. GE must prove it can grow before it warrants a share purchase. Buffett knows best, of course, but he got special terms the rest of us can’t command, like a 10% preferred dividend that will pay off even if the stock keeps falling, along with warrants that will gain value if the stock rises. Management’s confidence in the dividend is welcome, but it misleads, too. It was made possible only by the company halting its share repurchase program. The overall payout to stockholders, then, has already fallen.

The stock looks more tempting now than it has in a decade, but I suspect it will sell for a bigger discount still in coming quarters. For some other stocks to consider, have a look if you like at all six screen survivors. Run your own search anytime using SmartMoney’s stock screener and the full list of search criteria.

Trailing 12-month sales greater than $500 million
Dividend yield greater than 3%
Price/free-cash-flow ratio below 15
Beta less than 0.8
Return on equity greater than 15%