Finally, a Stock Passes My Screen

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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 12 candidates. Those stocks are being tracked on the F8's own CAPS page.

Today, we turn to the Modified Foolish 8. And, unlike the past couple of months, a stock actually passes the screen this time.

Mod-8 101
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, 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. 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 in real life but that we will do while tracking our results.

The envelope, please
Enough preamble; it's time to talk about the only stock to pass the screen this month. SolarWinds (NYS: SWI) sounds like it's involved in two types of emerging alternative energy, but it's not. It develops IT infrastructure management software for organizations of all sizes. I've mentioned before in this space that the company is doing its best to disrupt its industry by providing lower-cost solutions that are flexible and scalable.

Management seems to be focused on fast growth, and is expanding beyond IT infrastructure management and into markets such as network, application, storage resource, and more. International growth is also a priority, and makes up over a quarter or revenue already.

One way management sees to achieve that growth is through acquisitions, which can be a high-risk, high-reward strategy.

SolarWinds faces stiff competition in each of its markets, including bigger players like BMC Software (NAS: BMC) , NetApp (NAS: NTAP) , and EMC (NYS: EMC) . These three carry much more reasonable valuations -- each trading at 16 times next year's earnings or less -- but of course aren't expected to grow as fast as SolarWinds.

There may be M&A possibilities with these competitors, or with super heavyweights like Hewlett-Packard and IBM. This is a highly acquisitive industry and there's no telling what the future holds.

Onward and upward
Congrats to SolarWinds for being the sole Mod-8 survivor this month. Because I'm tracking and scoring each one of my monthly screens now, SWI will be the first CAPScall entry on this page. Add it as a favorite to keep track of things along with me.

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 is still waiting for the Three Dog Night reunion tour. He owns no companies mentioned in this article. The Motley Fool owns shares of BMC Software, IBM, and EMC. 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 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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