"Confidence falls even as corporate profits rise‎"

That headline from last week made me smile. Consumer confidence is one of the greatest contrarian indicators out there. Pair it up with record profits, and you've lined up a good buying opportunity. If you're an investor in the business of buying fear and selling greed, this is a good time to pick up some cheap stocks. And I've got five to get you going.

By the numbers
To find these stocks, I'm using my favorite valuation method: enterprise value over unlevered free cash flow. To elaborate:

  • Enterprise value: Market capitalization plus total debt and minority interests, minus cash.
  • Unlevered cash flow: Free cash flow plus interest paid on outstanding debt.

The ratio of these two metrics shows what the most popular valuation techniques, namely the price-to-earnings (P/E) ratio, do not. It shows what a company truly earns -- free cash flow with interest payments added back in -- in relation to enterprise value, or the value of capital owned by everyone with a stake in the company, both stock and bondholders.

This way, you, the shareholder, are forced to think about the interests and ramifications of bondholders. Why should you care? Because bondholders have to be taken care of before shareholders. In this sense, they're more important than you. Ignoring this simple truth -- basically, the concept of leverage -- has led to misery aplenty. GM shareholders will tell you all about it. If you owned a private business, this is the metric you'd naturally use to size things up. Think of it as a more comprehensive, more meaningful, P/E ratio.

Without further ado, here's five companies that look cheap:

Company

Enterprise Value to
LTM Unlevered Cash Flow

5-Year Average

CAPS Rating
(out of 5)

Microsoft (Nasdaq: MSFT)

11.6

19.5

***

CIGNA (NYSE: CI)

6.6

9.6

**

Raytheon Co. (NYSE: RTN)

7.5

14.6^

****

H&R Block (NYSE: HRB)

7.4

11.1

**

Stryker (NYSE: SYK)

9.7

25.9

*****

Source: Capital IQ, a division of Standard & Poor's.
^Through December 2009.
LTM = last 12 months.

Let's say a few words about these companies.

Microsoft
I wrote about how cheap Microsoft is a few weeks back. I want to say it again because the numbers are just too convincing. Microsoft trades at under 10 times forward earnings, has more cash than it knows what to do with, and serves untold millions of organizations that have built their entire information infrastructure around its products. Given Microsoft's profitability and the high likelihood that those profits will not only remain, but grow mightily into the future, a stock trading under 10 times forward earnings is perfectly crazy. Exploit that.

CIGNA
The more I learn about the new health-care law, the more convinced I am that its major points are symbolic political gestures underwritten by lobbyists. I don't see the ruinous assault on private enterprise others do. What I do see, and see everywhere, are health-care stocks still trading like death panels and socialist takeovers are imminent.

There are reform policies that will undercut earnings, mind you, but this reality seems to be priced into shares to the point of madness. As a group, health insurance stocks might be some of the cheapest out there. CIGNA trading at all of seven times forward earnings is a good example.

Raytheon
You can't mention Raytheon without talking politics; the company derived 88% of 2009 revenue from the U.S. government, after all. For that, I'll turn it over to Rep. Barney Frank, D-Mass.:

We have a very odd economic philosophy in Washington: It's called weaponized Keynesianism. It is the view that the government does not create jobs when it funds the building of bridges or important research or retrains workers, but when it builds airplanes that are never going to be used in combat, that is of course economic salvation.

Governments love two things: protecting their citizens and spending needless amounts of money doing it. That's a special treat for a company like Raytheon. Now, it's true that defense spending is slated to contract in coming years (at least that's what we hear; never forget the power of lobbyists), but Raytheon's valuation more than compensates for this.

H&R Block
H&R Block worried me during the 2008 presidential election as candidates talked seriously about simplifying the tax code. That's almost laughable today. To the contrary, think of the ever-growing bewilderment in today's tax code: What happens to the estate tax next year? Will the Bush tax cuts be extended? If so, for whom? What in God's name is the alternative minimum? The list of headaches is endless. As long as that's the case, people will beat a path to H&R Block's doors.

Yes, Intuit's (Nasdaq: INTU) TurboTax dominates the do-it-yourself market. But our tax code is so royally wacky that face-to-face consultations are still a necessity for millions. H&R Block's nearly 4% dividend yield adds to the appeal.

Stryker
Along with death and taxes, you can add osteoporosis and joint erosion to life's guarantees. That's why you should love a company like Stryker, manufacturer of an array of spinal implants, bone cement, and joint replacements for hips and knees. What I like about this company is twofold: Its products exploit a niche in the medical needs of aging baby boomers, and it's phenomenally well-run, thanks in part to insiders owning one-fifth of the company.

You take it from here
Disagree? Got any cheap stock ideas of your own? Sound off in the comments section below.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article, but probably will once the Fool's disclosure policy lets him. Microsoft and Stryker are Motley Fool Inside Value selections. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Stryker. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.