2 Promising Small Caps for April


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.

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.

And then there were...two!
Once again, SolarWinds (NYS: SWI) made the cut. However, for the first time this year, another company passed muster: Altisource Portfolio Solutions (NAS: ASPS) .

Altisource provides mortgage management services for loan originators and loan servicers, as well as other financial services. It has promising growth prospects, and for now the majority of its business -- about three-quarters worth -- is tied to three customers. One of them is Ocwen Financial (NYS: OCN) . Altisource and Ocwen were part of the same company until the two separated in 2009. Ocwen accounted for 58% of total revenue last year and is contractually tied to Altisource until August 2017.

For now, most of Altisource's resources are going toward Ocwen, and the latter's growth is particularly important to the former.

Meanwhile, I remain closely interested in SolarWinds as it expands it reach and crosses paths with larger competitors like NetApp (NAS: NTAP) and EMC (NYS: EMC) . I've mentioned before that the latter two are cheaper valuation-wise, but SolarWinds' upside is impressive.

Onward and upward
I'm tracking and scoring each one of my monthly screens now. Altisource will join SolarWinds as the lone entries 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 by clicking below -- and you'll gain access to The Motley Fool special report "Six Stocks to Watch from David and Tom Gardner."

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. He owns no companies mentioned here. The Motley Fool owns shares of EMC. 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.

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