At Motley FoolInsideValue, we spend our days looking for incredibly cheap bargain stocks. So why the heck would I be examining a stock whose trailing 12-month revenues shot up last year by almost 200%? That sounds more like a glamorous growth stock than a value pick, right? Have I completely cracked, shredded my Warren Buffett fan-club card, slain my former compatriots, and moved over to the dark side?

Well, not quite yet. The way I see it, when a stock with such ridiculous growth is trading at a trailing price-to-earnings (P/E) multiple below 15, then it's not a growth pick, it's just a great value. After all, value investing isn't about buying boring stocks in dead-end industries. It's about buying companies for less than they're worth, and that includes growth stocks when they're on sale.

The business
So what's the company? First Marblehead (NYSE:FMD), a provider of outsourcing services for private student loans. First Marblehead works with lenders and educational institutions to design student-loan programs, screen applications for creditworthiness, manage customer calls, and handle collections on loans. For all of this work, the company breaks even. First Marblehead actually makes its real profits through loan securitization, the process of bundling student loans and selling them on the securities markets.

To do this, First Marblehead acquires a bunch of student loans and pools them together. It then sells a security backed by this pool of loans, in a similar way to how your house backs your mortgage. The interest from the loans is paid as interest to the purchaser of the security. In this way, First Marblehead takes relatively illiquid student loans, any one of which has a high chance of defaulting, and creates an investment-grade security that can easily be sold to institutions. In return, First Marblehead receives advisory fees and retains a small "residual interest" in the securitized loans. That's where it makes its profits.

The competitive landscape
First Marblehead's major competitors include Sallie Mae (NYSE:SLM) and Wells Fargo (NYSE:WFC). However, the company has several competitive advantages. First, it's focused primarily on private loans, while its competitors tend to focus more on the larger federal loan market.

Second, the company has a technological leg up with its proprietary database that helps it accurately gauge default and prepayment rates, which is critical to correctly pricing securitized loans.

Plus, it has cool systems that facilitate online loan applications, obtain applicants' credit histories, and in most cases automatically approve or reject loans. The firm's automation also tackles the process of tracking loans and evaluating individual and aggregate risk. By avoiding human intervention except in tricky cases, First Marblehead operates very efficiently with far fewer employees than would be required in a less automated environment.

The sustainability of growth
There aren't many companies growing at such extreme rates that also have such low earnings multiples. There has to be a catch, and in First Marblehead's case, it's the growth. The company is very unlikely to keep growing at rates greater than 100%. After all, right now it owns about 16% of the market for private loans, and you can only double that market share so many times before you hit a ceiling. The company expects its loan growth in 2006 to be about 30% to 35%, significantly less than estimates for this year. Analysts project annual growth of about 25% over the next five years.

But even if First Marblehead achieves just 20% growth for the next five years, 10% for the next five, and 3% thereafter, my conservative estimate is that the company's still worth $50 to $60 per share. So, even with slower growth, the company looks cheap considering its current share price in the mid-$30s.

The risks
But there are other risks. Regulation is one, since the education market is particularly prone to meddling lawmakers. If the government increases the availability or the limits of federal loans, it could significantly curtail the private loan market and hurt First Marblehead's results. At the same time, though, regulation is not all bad. First Marblehead's solid knowledge of student-loan regulations is a competitive advantage that acts as a barrier to others entering the market.

Another risk is that First Marblehead derives much of its revenue from a few customers. In fiscal 2004, Bank One, a subsidiary of JPMorganChase (NYSE:JPM), accounted for 36% of First Marblehead's loans, Bank of America (NYSE:BAC) accounted for 22%, and Charter One accounted for 17%. So a falling out with one of these customers could significantly hurt First Marblehead.

Finally, if you examine First Marblehead's cash flow statement, you'll see that its free cash flow is significantly less than its earnings. This is a major red flag for any company -- one that demands explanation.

In this case, poor cash flow is a side effect of First Marblehead's loan securitizations. A significant portion of First Marblehead's advisory fees and residuals are received as cash long after the securitization transaction. In the case of residuals, First Marblehead books income now but doesn't get the corresponding cash for five or six years. These assets show up as income immediately and are recorded on the balance sheet at a discounted value, despite the fact that no money has yet come in.

It's quite difficult to value such assets, since their worth can dramatically shift depending on interest rates, default rates, and prepayment rates. Obviously, if few people pay off the loans, the assets won't be worth much. Or if everyone pays off their loans immediately, they won't be paying much interest. Either case is bad for the value of First Marblehead's residuals and would cause earnings to take a major hit. One has to look only at Doral Financial (NYSE:DRL) to see how much pain such asset revaluations can cause. So, overall, I consider First Marblehead's earnings relatively unpredictable and poor quality.

To sum up
First Marblehead shares trade at a large discount to intrinsic value, which like any value investor I really love to see. Its competitive advantages, while not comparable with some large multinationals, are nevertheless significant. However, the quality of its earnings is much weaker than the typical Inside Value stock pick, and that makes First Marblehead riskier.

Because volatility in First Marblehead's earnings and shares is likely, I wouldn't recommend it for your grandma's portfolio. But for investors willing to take on more risk, First Marblehead is interesting. It's rare that a company with such strong growth is available at such a bargain price. If First Marblehead avoids securitization pitfalls and sustains growth for a few years, today's stock price is shockingly cheap.

If you're interested in finding other shockingly cheap companies, for your grandmother or yourself, check out Inside Value's picks by clicking here to take a free 30-day trial.

Richard Gibbons, a member of the Inside Value team, has been called a marblehead on numerous occasions. He owns shares of Doral (an Inside Value recommendation) but does not have a financial position in other companies mentioned in this article. He's thinking about it, though.