5 Top-Rated Value Stocks

Are you familiar with the dynamic duo of Fama and French? No, they didn't sing "Private Eyes" -- that was Hall and Oates. And no, they didn't star in Tommy Boy -- that was Farley and Spade.

While the names Eugene Fama and Kenneth French may not come up in most dinner conversations, the two have done some of the most interesting academic research on stocks. In short, they've proposed that there's more to stock returns than volatility -- which was most academics' previous consensus. In research they conducted over various periods and across multiple geographic locations, Fama and French determined that stocks characterized as "value stocks" have consistently outperformed non-value stocks.

Today, I've rounded up five value stocks that are at the bottom of the bunch when it comes to price-to-free cash flow. To focus on high-quality stocks, I've cross-referenced these against ratings in our CAPS community of more than 83,000 investors.

Company

Free Cash Flow Multiple

30-Day Return

CAPS Rating (5 max)

ING Groep (NYSE:ING)

2.3

(20.4%)

****

Amerisafe (NASDAQ:AMSF)

2.8

1.4%

*****

Immersion (NASDAQ:IMMR)

2.9

(2.3%)

*****

Royal Bank of Canada (NYSE:RY)

3.2

5.5%

****

Asta Funding (NASDAQ:ASFI)

4.1

(14.6%)

****

Data from CAPS, Yahoo! Finance, and Capital IQ as of Feb. 15. Free cash flow = trailing operating cash flow less capital expenditures.

Though the CAPS community obviously likes these stocks, I would advise against investing in any of these on the basis of this one metric alone. With that I mind, I thought I'd dig a little further into the story at Rule Breakers pick Immersion.

The importance of research 
Cheap stocks aren't always as cheap as they appear. Allow me to explain. With nearly every stock that's gotten cheap enough to show up here come the blemishes that caused investors to let it get so cheap. Our job as investors is to make sure we understand why a stock has ended up so cheap and determine whether the risks have been overblown -- because if they have, then we could have a screaming value on our hands.

The case of Immersion is a great example of trading multiples being misleading. The low 2.9 free cash flow multiple above -- along with the 2.2 P/E ratio currently listed on Yahoo! Finance -- belie the fact that the stock is actually fairly expensive by other measures. The company has only produced $25 million in revenues through the first nine months of the year, and if you back out the $135 million patent settlement it received from a dispute with Sony (NYSE: SNE  ) , its net income of $123 million is, well, no longer income.

But in thinking about a company like Immersion -- whose bread and butter is creating and defending patented technology in the field of touch interaction -- you can't really ignore patent settlements, it's simply part of the business. Meanwhile, touch technology is gaining wider acceptance through a variety of areas like video games, surgical training, and the dashboard controls on your BMW (OTC BB: BAMXF.PK). For its third quarter -- which didn't include any legal settlements -- Immersion's revenue was up almost 50% from the prior year, and it posted a small but promising profit.

But is it cheap? Financial ratios aside, the company currently has more than $137 million in cash, equivalents, and short-term investments on its balance sheet, against a market cap of $276 million. If the promise of its technology pans out to even a moderate extent, investors should do quite well. Of course, most investors are not expecting a moderate success from the technology. CAPS All-Star veering, for one, expects much more. "Immersion's technologies will very likely drive the next paradigm shift in product usability and interaction across a range of consumer technology products."

So what do you think? Are these stocks values, or value traps? Log onto CAPS and let the rest of the 83,000-plus member community know what you think.

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