Are These Stocks Ready to Run?

This article is part of ourRising Star portfolios series.

One of the major goals of my Rising Star portfolio is to introduce and explain the various screens I use to find great stocks. (Another major goal is to make money. Of course.)

I'll be running each screen at least monthly. Plus, in pure Moneyball fashion, I am now tracking and scoring each so we'll know exactly what's working and what's not.

In the batter's box today: my "7 Signs of a Winner" screen.

The windup...
This particular screen was born out of my work with Motley Fool co-founder Tom Gardner for the Motley FoolHidden Gems service. Tom is always studying winning and losing stocks in order to learn how to better find the champions and avoid the dogs -- and I help him as best I can. A few years ago, we studied all of the Hidden Gems winners to find out what they had in common. We found that many of them shared these seven traits:

1. Double-digit rising sales: We view this as one of the most telling indicators of a real growth company. We love earnings growth as well, but earnings are too easily manipulated. Revenue growth, however, is a pretty pure marker of rising demand and pricing power.

2. Rising free cash flow and book value: While earnings can be fudged, cash is where it's at -- and great businesses generate lots of it. A company that's growing both its free cash flow and book value is on the right track.

3. Improving margins: The ability to take in more and more profit from each dollar of sales indicates competitive advantages and efficient management.

4. Rising return on equity: We use ROE as a decent proxy for how well a company allocates capital -- what Warren Buffett calls the most important aspect of management.

5. Insider ownership: This one's no surprise to all you veteran Fools out there. As shareholders of a company, we are part-owners of the business, and we'd like a significant portion of management to be our co-owners. That way, there's more incentive for them to act in our best interests. We look for ownership of 5% or more.

6. Regular dividends: Research indicates that dividend-paying companies tend to be better at managing capital and growing earnings. We feel that the pressure of making quarterly cash payments forces a certain discipline on managers, and deters them from such destructive habits as "empire building" -- that's when companies in search of something to do with their cash start making less-than-ideal acquisitions.

7. Out-of-the-way success: Many big winners come out of relative obscurity and are never media darlings or hot IPOs.

...and the pitch!
Armed with that information, the natural question to ask is, "How can I find companies that meet these standards?" Well, by screening, of course! Armed with my awesome Capital IQ screening tool, I looked for companies with more than $200 million in market cap that met the following criteria over the past 12 months:

  • Total revenue growth of 10% or better.

  • Free cash flow growth greater than zero.

  • Book value growth greater than zero.

  • Net margin growth greater than zero.

  • ROE growth greater than zero.

  • Insider ownership at least 5% or better.

  • Dividend yield greater than zero.

The only thing I can't screen for is out-of-the-way success, but if I feel a stock is overhyped and overvalued, I won't consider it for my portfolio.

Of the 3,453 companies on U.S. exchanges with a market cap of $200 million or greater, only 47 passed the screen.

NewMarket (NYS: NEU) is an interesting name on the list. This oddly diversified company makes lubricant additives for engine oil and other fluids, and engages in real estate development. It has grown revenue 21% over the last 12 months, and has 35% insider ownership. Cognex (NAS: CGNX) is another strong revenue-grower (26% year over year). It gives "sight" to machines though sensors and cameras that mimic the human eye. Its vast potential is exciting.

A couple of stocks from the energy sector also caught my eye. Seadrill (NYS: SDRL) provides offshore oil and gas drilling services. Capitalized at $15.8 billion, it's a large cap, but it still sports 29% insider ownership. But the most intriguing aspect to Seadrill is its whopping 9% yield. Berry Petroleum (NYS: BRY) , meanwhile, operates 3,500 oil and gas wells in the Southwest U.S., and has grown revenue at a 36% clip over the last 12 months.

At about $250 million in size, American Software (NAS: AMSWA) is the smallest company to pass the screen. Its software helps companies save money through supply-chain management and other services. Though tiny, it pays a 3.8% dividend, enforcing a financial discipline that Tom really likes to see in small caps.

Is it a hit?
Those are just a few that passed the screen, but I'll post the full list on my Rising Stars discussion board. I'll be looking through these companies to see whether any are right for my multivitamin portfolio, and will report back on my findings at a later date.

Also, beginning today, I'm tracking the results of companies that pass this screen. They'll be entered as a "buy" when they appear on the screen, and sold when they drop off. You can see the results so far on the 7 Signs Motley Fool CAPS page.

If you're interested in any of the companies I listed, add them to your very own watchlist by clicking below.

At the time thisarticle was published Fool analyst Rex Moore tweets but is not a twerp. He runs a real-money Rising Star portfolio based on his screens. Motley Fool newsletter services have recommended buying shares of Cognex. 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.

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