In the search for undervalued stock, value investors often turn to traditional metrics, screening for lower price-to-earnings, price-to-book and price-to-sales ratios. But even in the most ordinary of times these ratios are blunt instruments subject to misinterpretation and manipulation.

In the current environment, value investors need to be especially cautious. The denominator in each is suspect from a historical perspective and may be less reliable today.

Consider price-to-book ratios, for example. The book value of financial assets (loans, accounts receivable, etc.) is clearly subject to write-downs as the credit crisis unwinds. For nonfinancial assets, book value is based on historical cost, minus depreciation. But is a factory or retail store worth as much now as it was when it was more profitable? And how should intangible assets such as a brand be valued when the growth historically ascribed to a brand name may be very different going forward?

Similar questions could be raised about earnings and sales compared to historical precedent. In today's environment of potentially deflated earnings, any price-to-earnings ratio may not be as meaningful as it was in the past. Top-line growth may also need to be discounted. Value investors need both a framework with which to question assumptions and an expanded market view that is particularly relevant to a difficult economic outlook.

One approach is the classic DuPont analysis, developed early in the 20th century by the industrial giant to evaluate its own investment opportunities. This straightforward approach allows investors to frame their thinking about which corporate profit expectations might be realistic in this challenging economy.

Essentially, the DuPont formula tells us that return on equity is driven by tax rates; pretax profit margins; sales relative to assets; and assets relative to equity (leverage). Let's take a closer look at these four variables.

Tax Rates: It's safe to say that meaningfully lower corporate tax rates are not on the horizon, and an evaluation of historical profits should account for this.

Pretax Profit Margins: Profit margins are driven by pricing and costs. Pricing power is quite weak in a downturn, while costs may or may not be flexible. Costs such as manufacturing facilities or a complex distribution infrastructure are less flexible, while variable costs such as labor or advertising are more easily managed.

Sales Relative to Assets: Industries with high fixed costs, or operating leverage, may have severe earnings swings depending on their levels of sales. They have the advantage in good times of having lower incremental costs as sales increase, but the exact opposite situation prevails when volume or prices fall. Industries with higher variable costs, such as retail, may be more nimble cost-cutters in an economic downturn but remain exposed to a variety of headwinds.

Assets Relative to Equity (Leverage): Clearly, the highly leveraged corporate earnings achieved in the past need to be taken with more than a grain of salt. The amount of debt willingly carried, or even available, on corporate balance sheets is sure to moderate.

As with any metric of financial health, when making comparisons it's critical to kick the tires to better understand what's behind the numbers. The DuPont analysis, however, can focus your investment thinking on areas that should be stress-tested relative to historical experience.

Bonds can serve as a valuable source of confirmation for equity analysts and pickers of value stocks. The bond market focuses on solvency-including the ability to pay, balance sheet health and the certainty of cash flows. Bond-market consensus is less concerned with future business and earnings forecasts, or the impact of new products and markets.

Bond yield should also be compared to dividend and earnings yield. Investors should reexamine their investment thesis when considering a company with a bond yield that exceeds the earnings yield of its stock. The bond market's opinion has far too often proven to be more pragmatic than that of the equity market. The bond market, in fact, may be the ultimate value investor.

TIM KNEPP, CFA, serves as chief investment officer of Genworth Financial Asset Management (an Encino, Calif.-based unit of Genworth Financial), as well as chairman of the firm's investment management executive committee. He can be reached at tim.knepp@genworth.com.