2 Stocks With Big Potential

Before you go, we thought you'd like these...
Before you go close icon

This article is part of ourRising Star Portfolio series.

Today, my search continues for some great small- and mid-cap stocks to add to my real-money "multivitamin" portfolio. Last week, I revealed the results for this month's Foolish 8 screen and came up with six candidates. Today, we turn to the Modified Foolish 8.

Mod squad
For a refresher, here's a summary of the changes I made to turn the Foolish 8 into the Mod-8:

  • Raised the revenue cap to $900 million or less.
  • Took the $25 million limit off the daily dollar volume requirement, making it simply $1 million or greater.
  • Loosened the relative strength requirement to 50 or greater.
  • Required not only positive cash flow, but also positive free cash flow.
  • Required a price-to-free-cash-flow-to-cash-flow growth (PFCF-to-FCF growth) multiple of 1 or less. I have tweaked the screen to use actual FCF growth over the past year.
  • Required greater than 15% return on equity over the past four quarters, and for each of the past three fiscal years.

According to the independent American Association of Individual Investors, the Mod-8 has an average annual growth rate of 20.2% from January 1998 through May 2011. The S&P 500 averaged 2.5% annually over that period. (Disclaimer: The AAII methodology involves buying a stock the month it appears on a screen and selling when it's off -- something we'd never do. Still, this performance points to the screen's strong potential.)

Only two companies pass the screen this month.

Company

Market Cap (millions)

Business

Add to Your Watchlist

NetEase.com (NAS: NTES)

$6,326

Internet software/servicesAdd
LSB Industries (NYS: LXU)

$796

HVAC and chemical productsAdd

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

Both of the companies were on the screen last month, while iGATE (NAS: IGTE) dropped off. Digging deeper:

Company

Insider Ownership

Forward P/E

EV/FCF (TTM)

ROE

Net Margin

NetEase.com

45%

19.5

18.5

27%

43%

LSB Industries

17%

42.6

18.8

35%

10%

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

Onward and upward
In the coming days, I'll take a close look at these companies, as well as the small caps that passed last week's Foolish 8 screen. I'll soon report back on whether any of them are a good fit for the portfolio.

It's worth noting that these smaller companies can be quite volatile. lululemon athletica (NAS: LULU) , which has appeared on this screen in the past, is my best performer so far. My two positions are up 55% and 44% since purchasing in January and March, respectively. My II-VI (NAS: IIVI) positions, meanwhile, are down 18% and 29% from my April and May purchases.

If you're interested in keeping up with any of these companies, add them to your free watchlist by clicking the appropriate "add" button in the top table. To keep up with me, meanwhile, follow me on Twitter and check out the multivitamin discussion board. Fool on!

At the time this article was published This article is part of our Rising Star Portfolio 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 analystRex Moorereminds you that pain is mandatory, but suffering is optional. At the time of publication, he owned shares of lululemon. The Motley Fool owns shares of Lululemon Athletica and II-VI.Motley Fool newsletter serviceshave recommended buying shares of II-VI, NetEase.com, and Lululemon Athletica. 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.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Read Full Story

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.

From Our Partners