Cheat Sheet for Undervalued Stocks

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By David Sterman

NEW YORK (Street Authority) -- They say stocks "climb a wall of worry." Well, investors now have something new to worry about.

Concerns are growing that profit margins may have peaked for many companies in 2011 and could slip a bit in 2012 and 2013. It's a valid concern. In past economic cycles, companies operated in an ultra-lean fashion during periods of economic weakness, but needed to spend more money on staff and raw materials when the economy starts to strengthen.

If profit margins have indeed peaked and earnings-per-share (EPS) growth is hard to muster, then investors are likely to focus on other metrics that help point the way toward value. My favorite litmus test for a stock's value is in the area of free cash flow (defined as operating income minus capital spending). Every dollar of free cash flow goes right to the cash balance, giving a company even greater flexibility in terms of dividends, stock buybacks and acquisitions.

Hertz enjoyed a big jump in free cash flow in 2010.

Perhaps of greater import, free cash flow yields (defined here as the free cash flow divided by the market capitalization -- though some prefer to use enterprise value) are so much higher than actual yields on government or corporate bonds. Any time you can find a company with free cash flow yields in excess of 10%, you need to take notice.

I've found 15 of them.

Actually, I found more than 50 of these free cash flow yield powerhouses, based on 2010 results. I narrowed the list down to companies that are likely to post robust free cash flow in 2011 (when results are announced) and 2012 as well.

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