Can Any Stock Pass This Tough Test?

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This article is part of ourRising Star Portfolios series.

Today, my search continues for some great small- and mid-cap stocks to add to my real-money "multivitamin" portfolio. Yesterday, I revealed the results for this month's Foolish 8 screen and came up with 11 candidates. Today, we turn to the Modified Foolish 8.

Except...

Where have you gone, Joe DiMaggio?
For the first time ever, not a single stock passed the Mod 8 screen this month. I had a feeling this could happen, because only one or two stocks have passed in recent months.
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 one 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, or AAII, the Mod 8 has had average annual returns of 15% from January 1998 through October 2011. The S&P 500 averaged 1.9% 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.)

LSB Industries managed to pass last time, but this month...nothing. Here's a look at some that almost made it, and which criterion they failed.

Company

Market Cap (millions)

Industry

Missed Criterion

lululemon athletica (NAS: LULU)

$6,500

Textiles, Apparel and
Luxury Goods

P/FCF-to-FCF Growth ratio

MercadoLibre (NAS: MELI)

$4,136

Internet Software
and Services

P/FCF-to-FCF Growth ratio

IPG Photonics (NAS: IPGP)

$1,804

Electronic Equipment, Instruments and Components

Return On Equity requirement

Nanometrics (NAS: NANO)

$414

Semiconductors and
 Semiconductor Equipment

Return On Equity requirement

3D Systems (NYS: DDD)

$784

Computers and Peripherals

Return On Equity requirement

CARBO Ceramics (NYS: CRR)

$3,117

Energy Equipment and Services

P/FCF-to-FCF Growth ratio

LSB Industries

$673

Chemicals

P/FCF-to-FCF Growth ratio

Source: S&P Capital IQ.

MercadoLibre and Nanometrics were among the 11 that made yesterday's Foolish 8.

Onward and upward
So nothing this month from the Modified Foolish 8, but the small caps that passed yesterday's Foolish 8 screen are still in play for me. I'll soon report back on whether any of them are a good fit for the portfolio. So far, I've bought four stocks off these two screens: LSB Industries, lululemon athletica, II-VI, and Kulicke & Soffa (NAS: KLIC) .

If you're interested in keeping up with any of these companies, just add them to your free watchlist -- and you'll gain access to The Motley Fool special report "Six Stocks to Watch from David and Tom Gardner."

At the time this article was published Fool analyst Rex Moore runs a real-money portfolio based on his screens. Follow along on Twitter. Of the companies mentioned in this article, Rex owns shares of lululemon athletica. The Motley Fool owns shares of II-VI, lululemon athletica, IPG Photonics, Kulicke & Soffa Industries, 3-D Systems, and LSB Industries. Motley Fool newsletter services have recommended buying shares of MercadoLibre, lululemon athletica, IPG Photonics, and II-VI. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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

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