This Month's High-Risk, High-Reward Small Caps

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, seven companies passed the screen, down from 12 in April:

Source: S&P Capital IQ.

Fortinet, Hi-Tech Pharmacal, Ocwen Financial, REX American Resources, Transcend Services, Main Street Capital, and ZAGG (NAS: ZAGG) dropped off the list from last month. ZAGG, the maker of accessories for smartphones, tablets, etc., is highly polarizing and quite popular among many of our readers. For those curious, it passed everything but the relative strength requirement, having fallen to the 81st percentile. Close to a third of its shares are sold short, and I expect continued volatility from ZAGG.

The new stocks this month are Healthstream and Spectrum Pharmaceuticals. Healthstream provides Internet-based learning (71% of revenue) and research (29%) services for the health industry. It's currently growing revenue at about a 25% rate, but is priced at more than 65 times next-12-month's earnings.

Spectrum, meanwhile, is priced at just 8 times forward earnings and has nearly doubled revenue over the past year. It develops drug products primarily in the areas of hematology and oncology. We have good exposure in this sector with both Abbott Laboratories and Johnson & Johnson, but I'm going to have some fun digging into Spectrum as well.

Akorn reported earnings earlier this month, beating on both the top and bottom lines, but the margin picture was mixed. The stock is outperforming in our Foolish 8 tracker, beating the market by 17 percentage points since it hit the screen two month ago.

Meanwhile, I've missed out on a 50% gain from SolarWinds while taking my time with the research. But that's the way it goes sometimes, and the stock remains under strong consideration.

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 taking.

At the time thisarticle was published Fool analyst Rex Moore reminds you that time holds the winning hand. He owns shares of Johnson & Johnson. The Motley Fool owns shares of Johnson & Johnson and Abbott Laboratories. Motley Fool newsletter services have recommended buying shares of Liquidity Services and Johnson & Johnson. Motley Fool newsletter services have recommended creating a diagonal call position in Johnson & Johnson. 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.

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