July 25 (Bloomberg) -- The Perfect 10 Portfolio was far from perfect in the past year.

This collection of cheap stocks, which I compile each July, fell 0.43 percent from July 21, 2005, through July 21, 2006. By comparison, the Standard & Poor's 500 Index rose 3 percent, including reinvested dividends.

The expression ``Perfect 10'' refers to a strikingly beautiful woman, as exemplified by Bo Derek in the 1979 movie ``10.'' I have adopted the expression to illustrate the beauties of investing in out-of-favor stocks.

My Perfect 10 portfolio contains 10 stocks, each one selling for 10 times earnings, as of the time the portfolio was created (this year, July 21). That is cheap compared to the current multiple on the S&P 500 (about 17) and the long-term average (about 15).

In the six years that I have compiled the Perfect 10 Portfolio, it has achieved an average one-year return of 17 percent, compared to 2.2 percent for the S&P 500. It has beaten the index four times out of six.

The past 12 months were one of the two exceptions. Half of the Perfect 10 stocks fell. The worst loser was Sigmatel Inc. (SGTL), an Austin, Texas, company that makes circuits used in MP3 players and other consumer-electronics devices. It dropped 82 percent.

The best gainer was Inco Ltd. (N) of Toronto, the world's second-biggest nickel producer. Inco has received two unsolicited takeover offers and may be in line for more. Its stock is up 67 percent for the year ended July 21.

Let's see if I can get the Perfect 10 Portfolio back on track for its seventh outing.

Cummins, U.S. Steel

I'll lead with Cummins Inc. (CMI), the world's largest maker of high-power diesel engines. Based in Columbus, Indiana, Cummins gets more than half its sales from countries outside the U.S., and is in the process of setting up its ninth venture in China.

Cummins stock sells for only 0.49 times revenue, and -- of course -- 10 times earnings.

Next, I recommend U.S. Steel Corp. (X), the largest American steelmaker. Despite a lot of talk about steel prices coming down, sheet-steel prices were at $605 a ton in June, the highest in 15 months. U.S. Steel has made progress in reducing debt, excessive labor costs and health-care costs. The Pittsburgh-based company has a fair chance of posting record earnings this year.

In the energy field, I have two picks -- Grey Wolf Inc. (GW) and Swift Energy Co. (SFY), both based in Houston.

Grey Wolf is a contract driller that is on the comeback trail. After posting losses in 2002 and 2003, it earned $8 million in 2004 and $121 million in 2005. This year, analysts expect another big increase.

Grey Wolf's fleet of 114 rigs is geared mostly to natural gas drilling. Because natural gas, unlike oil, is hard to transport from the Middle East, I see a need for intensified drilling in the U.S. for the next several years.

Swift, Hartford

Swift explores for oil and gas onshore and offshore, mostly around Texas and Louisiana, and also in New Zealand. It has posted a profit four years in a row, and in 16 of the last 19 years.

Last year Swift posted record earnings of $3.95 a share. This year analysts look for $4.92, and $5.07 next year. With the stock a little over $43, it looks like a good investment to me.

Hartford Financial Services Inc. (HIG) has posted profits in 11 of the past 13 years. The Hartford, Connecticut-based company sells property and casualty insurance, life insurance, annuities and investment products. Last year it earned $2.2 billion. I consider it a bargain at 10 times earnings and 0.92 times revenue.

Komag, Avnet

Next I recommend Komag Inc. (KOMG), a San Jose, California, maker of components for computer disk drives. Analysts expect a smart jump in earnings this year, to about $4.70 a share from $3.55.

Investors right now are leery of technology stocks, which could create buying opportunities. Considering its sparkling 33 percent return on stockholders' equity last year, I think Komag is a bargain at 10 times earnings and 1.6 times revenue.

I also like Avnet Inc. (AVT), based in Phoenix, the world's largest distributor of electronic components. Avnet reported profits in 17 of the past 19 years, yet its stock is selling for only 0.94 times book value (assets minus liabilities per share) and 0.18 times revenue.

In the financial realm, I recommend Lehman Brothers Holdings Inc. (LEH), a New York-based securities firm. Lehman has posted profits 12 years running, and analysts look for a 20 percent earnings increase this year. The firm consistently does well in surveys of analysts' research.

Return Showing

I will bring back one pick from last year, Methanex Corp. (MEOH), which was up 21 percent. Based in Vancouver, Methanex produces and markets methanol, a chemical used as a gasoline additive and in making formaldehyde and acetic acid. Methanex has a six-year profit streak going, and analysts anticipate that earnings will climb to $2.81 a share this year, from $1.89.

To round out the portfolio I pick Ohio Casualty Corp. (OCAS), a property and casualty insurance company from Fairfield, Ohio. The company has posted improved quarterly earnings (on a year-over-year basis) for 11 straight quarters, and has been profitable in 12 of the past 14 years.

Disclosure notes: I own U.S. Steel personally and for many clients. I own Cummins for a few clients. Currently I do not own the other shares discussed in this column. My firm does business with Lehman Brothers.

To contact the writer of this column: John Dorfman in Boston jdorfman@bloomberg.net.

Last Updated: July 25, 2006 00:07 EDT