This Recession Is Gonna Make Me Rich (Again)

Investors today face a dilemma. With the Dow down some 40% from its peak, top investors like Chuck Akre, Whitney Tilson, and Warren Buffett keep reminding us that stocks are cheap.

On the other hand, every day, newspapers report another round of layoffs, and bleak headlines leave us all wondering how low stocks can go.

So if you think today's an utterly lousy time to invest, well, I certainly can't blame you.

That said ...
Do you remember the Internet bubble? I sure do. When the Great Bubble burst in 2000, I saw my portfolio fall directly into the commode -- down 40% in the space of a few months.

See, back in 2000, I bought into the worst of the worst tech stocks. The overhyped Palm IPO. The overpriced Cisco. The soon-to-be-bankrupt Winstar. And I paid the price for my mistakes. But as the market slowly turned around, I eventually recovered my losses -- and then some.

Of course, the financial crisis we are facing today is far more widespread and threatening than the Internet bubble was. Nevertheless, over the course of time, I learned that building real wealth consists of three simple, timeless steps:

• Earn as much as you possibly can
• Save as much as you possibly can from what you earn
• Invest those savings

Working as many as five jobs simultaneously, my wife and I scrimped and saved. We cut corners. And no matter how much we took home from work, we strove (not always succeeding, I admit) to put away at least a third of our income for a rainy day. Then we invested it.

Invested in what?
I set out to describe the investment philosophy I learned from Motley Fool co-founder Tom Gardner. The result was a 2004 column I entitled "7 Steps to Finding Gems." You can read it for yourself just by clicking through the link, but here's the dime tour:

I invested in companies that:

• Had superb management
• Generated significant free cash flow
• Grew that cash flow quickly, and
• Traded for cheap prices

How low? To keep it simple, I like to see companies selling for a price-to-free cash flow-to-growth (P/FCF/G) ratio of less than 1.0. It's really a fancy-pants version of the PEG ratio, popularized by legendary former Magellan Fund manager Peter Lynch. I prefer free cash flow over GAAP earnings as a measure of profitability; while GAAP profits may be good enough for the SEC, I believe free cash flow is a more reliable indication of financial health.

Now here's the best part
It was easy finding great companies that fit this criterion after the Internet bubble burst. But ever since 2005, I've been having trouble finding many stocks selling for as cheap as I'd like to pay -- until today.

Thanks to the Great Sell-Off of '08, stocks finally offer investors today the chance to buy good companies on the cheap. Running one of my favorite stock screeners in search of bargains last week, several likely suspects popped right up, each trading at or near my target valuation, and each rated four or five stars from our 130,000-member CAPS investment community:

Data from Finviz.com and Yahoo! Finance. *Based on consensus 5-year earnings growth estimates.

One word of warning
Screens like this one can help you to find bargains, but they've got their limits as well. For example, if you dig into the balance sheets on these firms, you'll notice that many of them carry some debt -- and with the high capital costs of extracting oil, "Petrobras" carries quite a lot of the stuff. Arguably, this means the companies are a bit more expensive than they seem at first. (In financial terms, we'd say their "enterprise value" is higher than their price.)

Coversely, Broadcom and Sohu all have significant net cash reserves -- making them even better prospects for investment. While they vary in degree of attractiveness, though, each and every stock on the list looks value-priced to me.

Of course, if you want to be really certain that a stock is as good as it seems -- or maybe even better than it seems -- you might want to give our Motley Fool Hidden Gems small-cap investing newsletter a whirl. Since starting up in the middle of the bear market of 2003, our team of small-cap treasure hunters has beaten the S&P 500 considerably. Take a free trial, and you can follow along as we invest $250,000 of real money in our top investment ideas.

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This article was first published March 10, 2009. It has been updated.

Fool contributor Rich Smith does not own shares of any company named above. Petrobras is an Income Investor selection. Sohu is a Rule Breakers pick. Nasdaq OMX is an Inside Value recommendation and Fool holding. The Motley Fool has a disclosure policy.