High-Risk, High-Reward Small Caps

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This article is part of ourRising Star Portfolios series.

I'll be gathering more small- and mid-cap candidates for my Rising Star "multivitamin" portfolio over the next few days via my Foolish 8 and modified Foolish 8 screens. Today I present the Foolish 8, which was developed by Motley Fool co-founder David Gardner to identify profitable, rapid-growth small-cap stocks. Here are the eight criteria:

1. Revenues: $500 million or less.


2. Earnings and sales growth: 25% or greater.

3. Netprofit margin: 7% or greater.

4. Daily dollar volume: $1 million-$25 million.

5. Insider holdings: 10% or greater.

6. Share price: $7 or greater.

7. Relative strength: 90 or greater.

8. Operating cash flow: a positive number.

The contenders
This month, 12 companies passed the screen:

Akorn (NAS: AKRX) $1,100PharmaceuticalsAdd
Altisource Portfolio Solutions$1,360Real estate management and developmentAdd
American Vanguard (NYS: AVD) $686ChemicalsAdd
Fortinet (NAS: FTNT) $4,345SoftwareAdd
Hi-Tech Pharmacal (NAS: HITK) $443PharmaceuticalsAdd
Liquidity Services$1,549Internet software and servicesAdd
Main Street Capital$657Capital marketsAdd
Ocwen Financial$1,983Thrifts and mortgage financeAdd
REX American Resources$253Oil, gas and consumable fuelsAdd
SolarWinds$2,792SoftwareAdd
Transcend Services$314Health-care technologyAdd
ZAGG (NAS: ZAGG) $339Household durablesAdd

Source: S&P Capital IQ.

Inside ownership seems to be a big theme with this bunch. Akorn, Altisource, Hi-Tech Pharmacal, Liquidity Services, REX American Resources, and ZAGG all exceed 20% ownership. Fortinet carries the highest multiple based on the next 12 months' earnings (53), but that's not always a big negative with these small caps. The network security specialist is expected to grow EPS at about 20% annually over the next five years.

American Vanguard first hit the list last month, and holds the distinction of being the best performer thus far, with a 26% gain during that time. Hi-Tech is the biggest loser, down 8% since January, but that's 14 percentage points behind the S&P 500's performance. Still, my tracking just started this year, and we're less interested in these short-term results than what happens in the long term.

I hear CAPS calling
As I mentioned, I'm tracking and scoring each one of my monthly screens now so we can see exactly how they're performing. We refer to it as a CAPScall around these parts, and the Foolish 8 has its own page. Just add it as a favorite to keep up.

Tomorrow, I'll reveal the results of this month's modified Foolish 8 screen, and then talk about the companies that interest me from both screens in more depth.

If you're interested in keeping up with any of these businesses, add them to your free Watchlist by clicking the "add" button in the far right column of the table. You can also follow me on Twitter, and check out the multivitamin discussion board.

If you're looking for something to balance out your risky small-caps, consider our special free report detailing the best of the steady dividend payers. It's called "Secure Your Future With 9 Rock-Solid Dividend Stocks," and it's yours for the asking.

At the time this article was published Fool analyst Rex Moore reminds you that time holds the winning hand. He owns no companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Liquidity Services. Motley Fool newsletter services have recommended writing naked calls on ZAGG. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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