7 Signs of a Winner

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This article is part of ourRising Star Portfolios series.

One of the major goals of my Rising Star Portfolio is to introduce and explain the various screens I use to find great stocks. (Another major goal is to make money. Of course.)

I'll be running each screen at least monthly. In the batter's box today: my "7 Signs of a Winner" screen.

The windup...
This particular screen was born out of my work with Motley Fool co-founder Tom Gardner for the Motley FoolHidden Gems service. Tom is always studying winning and losing stocks in order to learn how to better find the champions and avoid the dogs -- and I help him as best I can. A few years ago, we studied all of the Hidden Gems winners to find out what they had in common. We found that many of them shared these seven traits:

  1. Double-digit rising sales: We view this as one of the most telling indicators of a real growth company. We love earnings growth as well, but earnings are too easily manipulated. Revenue growth, however, is a pretty pure marker of rising demand and pricing power.
  2. Rising free cash flow and book value: While earnings can be fudged, cash is where it's at -- and great businesses generate lots of it. A company that's growing both its free cash flow and book value is on the right track.
  3. Improving margins: The ability to take in more and more profit from each dollar of sales indicates competitive advantages and efficient management.
  4. Rising return on equity: We use ROE as a decent proxy for how well a company allocates capital -- what Warren Buffett calls the most important aspect of management.
  5. Insider ownership: This one's no surprise to all you veteran Fools out there. As shareholders of a company, we are part owners of the business, and we'd like a significant portion of management to be our co-owners. That way, there's more incentive for them to act in our best interests. We look for ownership of 5% or more.
  6. Regular dividends: Research indicates that dividend-paying companies tend to be better at managing capital and growing earnings. We feel that the pressure of making quarterly cash payments forces a certain discipline on managers and deters them from such destructive habits as "empire building" -- that's when companies in search of something to do with their cash start making less-than-ideal acquisitions.
  7. Out-of-the-way success: Many big winners come out of relative obscurity and are never media darlings or hot IPOs.

...and the pitch!
Armed with that information, the natural question to ask is, "How can I find companies that meet these standards?" Well, by screening, of course! Armed with my awesome Capital IQ screening tool, I looked for companies with more than $200 million in market cap that met the following criteria over the past 12 months:

  • Total revenue growth of 10% or better.
  • Free cash flow growth greater than zero.
  • Book value growth greater than zero.
  • Net margin growth greater than zero.
  • ROE growth greater than zero.
  • Insider ownership at least 5% or better.
  • Dividend yield greater than zero.

The only thing I couldn't screen for is out-of-the-way success, but we can do that mentally at the end.

Of the 3,621 companies on U.S. exchanges with a market cap of $200 million or greater, only 22 passed the screen:

Company

Market Cap
(in Millions)

Insider
Ownership

1-Year Price Change

Oracle (NAS: ORCL)

$154,903

22%

29%

Broadcom (NAS: BRCM)

$19,833

9%

1%

MSC Industrial Direct

$3,951

27%

24%

Royal Gold

$3,558

5%

47%

MercadoLibre (NAS: MELI)

$3,505

13%

31%

Jarden

$2,843

6%

6%

HEICO

$1,799

15%

66%

PriceSmart

$1,750

21%

114%

ASM International

$1,586

21%

6%

Cognex (NAS: CGNX)

$1,408

8%

81%

Textainer Group

$1,269

9%

(5%)

ABM Industries

$1,196

17%

2%

Industrias Bachoco

$1,171

83%

25%

NIC

$817

10%

66%

Internet Initiative Japan

$806

7%

45%

The Ensign Group

$594

22%

58%

Houston American Energy (ASE: HUSA)

$512

39%

65%

Epoch Investment Partners

$453

34%

57%

Monmouth Real Estate Investment

$292

6%

5%

Fundtech

$288

7%

59%

Nam Tai Electronics (NYS: NTE)

$262

25%

41%

Deer Consumer Products (NAS: DEER)

$221

47%

(19%)

Source: Capital IQ, a division of Standard & Poor's.

If you're looking for a free screening tool, start with the Motley Fool CAPS screener. It can't do everything the industrial-strength Capital IQ is capable of, but it's a good start.

Is it a hit?
I'll be looking through these companies to see whether any are right for my multivitamin portfolio and report back on my findings at a later date. To keep up, simply follow me on Twitter or check in on my discussion board. Finally, if you're interested in any of the companies I listed, add them to your very own personal watchlist!

At the time this article was published This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks.Click hereto see all of our Rising Star analysts (and their portfolios).Fool analyst Rex Moore parks on a driveway and drives on a parkway. Of the companies mentioned here, he owns shares of MSC Industrial Direct. The Motley Fool owns shares of Nam Tai Electronics and Oracle.Motley Fool newsletter serviceshave recommended buying shares of MercadoLibre, Nam Tai Electronics, Cognex, and MSC Industrial Direct. A separate service has recommended shorting MercadoLibre. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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