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 that I've read. 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 (out of 5)
Grupo TMM (NYSE: TMM)	0.7	(2%)	*****
Universal Insurance Holdings (AMEX: UVE)	1.9	(11%)	****
WellCare Health Plans (NYSE: WCG)	3.8	8%	****
USG (NYSE: USG)	4.0	4%	****
Alon USA Energy (NYSE: ALJ)	4.2	(25%)	****

Data from CAPS, Yahoo! Finance, and Capital IQ as of Feb. 8. 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 them on the basis of this one metric alone. With that I mind, I thought I'd dig in a little further on the story at Inside Value favorite USG.

The importance of research
Cheap stocks aren't always as cheap as they appear. Allow me to explain. Nearly every stock that's gotten cheap enough to show up here has blemishes -- which is why investors 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 blemish on USG isn't hard to see -- it's the same blemish that's been sweeping the nation and causing a whole heck of a lot of heartburn. You know it, you love it: It's the downturn in the residential housing market. As major U.S. homebuilders like KB Home (NYSE: KBH) and Toll Brothers (NYSE: TOL) have had to cut back on their building activities, there's been a lot of slack in the demand for the gypsum wallboard that USG manufactures.

As fellow Fool Emil Lee pointed out in his coverage of USG's fourth quarter, the low demand has stomped on the going price for wallboard, while costs on the other end have been creeping up. The result was a net loss of $28 million for the fourth quarter and a decline in net income of 74% for the full year.

But while profits have been hit hard, there's still reason to give the company a second look. Its balance sheet remains relatively strong, and cash flow from operations in 2007 was $1.3 billion. Meanwhile, this is arguably the strongest company in an industry that is going through a cyclical downturn. The downturn could even help USG by squeezing out lower-quality competitors.

You don't have to look far for a USG bull on CAPS -- there are more than 1,600 of them. One of them, CAPS All-Star Deepfryer, had this to say:

"I think this stock has hit rock bottom, and the latest rate cut should help it start to turn around. Remember, [Warren] Buffet bought a ton of USG when it was around $50 a share. Hold at least until it gets up to 50 or 60, however long that takes, and don't worry about short-term fluctuations."

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

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