Three cheap stocks for a crisis

Mr Dreman's long-term approach to investing is to buy stocks with ratings that suggest the market has given up on them, but with fundamentals that suggest there is still every reason for hope. The basic principle behind this approach is Mr Dreman's belief that the market overreacts to events and stocks become underpriced due to poor sentiment. Mr Dreman also believed that buying stocks that are underrated offers protection to investors because further small disappointments will not be punished whereas highly-rated stocks can be decimated by the merest hint of bad news.

Earlier this year we screened for either low-price-to-cash flow or high-dividend-yield shares that passed his tests. We're revisiting the screen searching for stocks that fit either, or both, of his criteria for low-price-to-book-value (PBV) or low-price-to-earnings (PE). By 'low' we mean shares with valuations among the lowest fifth of all the stocks we've looked at. Size mattered to Dreman, so we've only looked at companies that have a market cap of over £200m

For lowly-valued stocks to be of interest they have to show fundamental strength based on a broad range of criteria. Only three stocks made it through the test and only one, Petropavlovsk, qualified as both a low-PE and low-PBV stock. Two of the three stocks are gold miners, which tallies with Mr Dreman's view that entire sectors can become undervalued. That said, as miners tend to be essentially geared plays on the commodity they mine, a positive view on gold is crucial to backing these companies' prospects. The IC's view on the yellow metal is currently mildly positive with Dominic Picarda, the Trader, most recently saying there could be a further set-back before a bounce in the price.

This is our screening criteria:

■ Improved EPS growth in the most recent six-month period;

■ Positive forecast EPS growth;

■ A return on equity of over 10 per cent, which acts as a basic measure of underlying business quality;

■ Gearing of less than 75 per cent;

■ A current ratio of more than 1. The current ratio is a measure of easily realisable assets and indicates a business that can cope with the unexpected;

■ Above-average dividend yield;

■ A payout ratio (the amount of available profits that are paid to shareholders as dividends) of less than either two-thirds or the five-year average, which suggests the company is not overstretching itself with the current level of dividend.

Petropavlovsk

Not only is Petropavlovsk the only company to pass both the price-to-book value and PE tests in our current screen, it also qualified as a cheap Dreman price-to-cash-flow stock in a previous screen. So what makes the company so unloved aside from the market's current jitters about the gold price, which has recently been acting more like a standard commodity rather than a hedge against currency debasement? A key concern for investors is that the group operates in Russia. As BP's recent exit from the region demonstrates, doing business there is high risk. There are also some concerns about debt levels, but capital expenditure is expected to fall now, which should help. Operationally, the company has been doing very well, though, with both production and reserves showing impressive rises of late. If the market switches its focus to this aspect of the business rather than the undeniable risks, then there is room for a significant re-rating. Last IC view: Buy, 633p, 28 Mar 2012

*Based on EPS for the last 12 months

Source: S&P Capital IQ

Pan African Resources

African gold miner Pan African Resources looks like it is at a pivotal stage in its development as it pushes ahead with an acquisition that could almost double its production. The group is going ahead with the £113m acquisition of the Evander mine despite the fact that its bidding partner recently pulled out. The mine it is acquiring holds a number of technical challenges for its operator and was never intended to be mined so deep. However, the seller, Harmony, has made some major investment in the mine prior to its disposal and Pan African's management team has significant experience of mining in the region. The group will have to take on debt to fund the deal. There are risks with such a large and complex acquisition, but the price being paid could prove a bargain if everything comes off and the ore in the mine is high grade. Last IC view: Buy, 14p, 1 Jun 2012

Computacenter

While IT services company Computacenter is in a cyclical business, it has managed to produce double-digit increases in profits over the last seven years. Ironically, its success in shoring up the business over recent years by winning work in Germany and France is also the cause of negative sentiment now. Investors fear the company's exposure to the euro currency will hit results this year. Then there is the worry of the prospect of a global recession focused on a eurozone financial crisis that would inevitably hit business. Meanwhile, the UK still looks sluggish for the group. That said, recent order intake has been encouraging and the group is known for its excellent cash generation. Indeed, the shares managed to make it through our recent cash hoarders stocks screen. Last IC view: Buy, 411p, 13 Mar 2012