This Recession Is Gonna Make Me Rich (Again)

Investors today face a dilemma. With the Dow still down nearly 30% from its peak, top investors like Chuck Acre, 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 Sun Microsystems (NASDAQ:JAVA). The soon-to-be-bankrupt Winstar. 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 cheap? To keep it simple, I sought out 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 now.

Thanks to the Great Sell-off of '08, stocks finally offer investors today the chance to earn the kind of profits I reaped back in 2001-2005. Yes, even now that the market has "returned from the dead," bargains still abound. Running one of my favorite stock screeners in search of bargains last week, several likely suspects popped right up, each trading below my target valuation:

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

Word to the Foolish
Now I cannot emphasize enough how you should use the names and numbers as a starting point only, for your research. Dig around in the newsfiles for these companies, and you're bound to find a surprise or two that may warn you away from them.

Take China Mobile for example. By any metric you choose, China Mobile seems one of the strongest prospects on the list. It sells for a tiny multiple to cash profits, boasts boatloads of cash in the kitty, carries only modest debt, and appears to be growing like wildfire. So what's the catch? Why's the stock so cheap?

Hint: Because it's in China
A famously tricky place to do business in, China also does a good job of confounding the individual investor. As a "foreign" firm, China Mobile need not file the 10-Qs and 10-Ks that we are all so familiar with. Instead, it sends the SEC opaque "6-K" reports, dozens of which you can find on the SEC's website ... and none of which give you any clue what lies inside. Invest in China Mobile, therefore, and you must be prepared to spend a lot of time wading through uninformative SEC-speak, in hopes of finding the data you seek. (Even worse -- the data may not be there at all. It's been more than four months since China last filed an update on its financials for ... June 2009. Data that's now six months old!)

Foolish takeaway
Now, none of the above means that China Mobile is a bad business, or a bad investment. But it does mean that investing in this company involves a bit more work than the average stock will require.

If you could use little help with that, though, then have we got a deal for you! At Motley Fool Hidden Gems, we don't let a little extra paperwork scare us away from investments that have walloped the S&P's returns for nearly six years. We tackle 'em with a will, convinced the rewards are worth the work. Take the service free trial on our dime for 30 days. No strings attached.

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. The Motley Fool has a disclosure policy.