1 Disruptive Stock for March

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

Today, we turn to the Modified Foolish 8. Last month, a stock finally passed the screen after a two-month dry spell in which no company made the cut. This month, the same stock stands alone on the list.

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 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 outstanding average annual returns of 14.6% from January 1998 through January 2012. The S&P 500 averaged just 2.2% 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
Once again, SolarWinds (NYS: SWI) is the only stock passing the screen this month. The Austin, Texas, company develops IT infrastructure management software for organizations of all sizes.

SolarWinds has what it calls a "disruptive and unique model into new IT management markets," and as it expands it butts heads (or continues to butt heads) with the likes of BMC Software (NAS: BMC) , VMware (NYS: VMW) , NetApp (NAS: NTAP) , and EMC (NYS: EMC) .

SolarWinds is priced at a premium compared to all but VMware. But these are all much larger companies, and I see SolarWinds growing at a faster pace as it continues to build out beyond network management into other areas of IT management.

The one big concern is acquisitions -- SolarWinds does a lot of them. How well management can integrate all of these is a key to the future. The company's intangible assets ratio -- simply the percentage of total assets comprised of goodwill and other intangibles -- is at a very high 47%. It seems to run in the industry, as BMC and EMC are also over 40%.

I'm generally comfortable with that ratio below 20%, as explained in my ongoing series on goodwill and intangibles. So as I investigate whether SolarWinds is right for my portfolio, the top priority for me is to decide whether management has the ability to, um...manage all these acquisitions.

Onward and upward
I'm tracking and scoring each one of my monthly screens now, and SolarWinds will remain the lone entry on the Modified Foolish 8 CAPS page. Add the page 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 all out of clever lines. He owns no companies mentioned in this article. The Motley Fool owns shares of EMC and BMC Software. Motley Fool newsletter services have recommended buying shares of VMware. 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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