2 Promising Small Caps for June


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.

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.

Two at the top
(NYS: SWI) and Altisource Portfolio Solutions (NAS: ASPS) are the only two companies passing the screen this month -- their third consecutive month alone in the limelight. I've already gone into detail on why I like SolarWinds; mainly, I think its disruptive approach will work in the IT management industry. Altisource is a mortgage management services provider for loan originators and loan servicers, and should benefit when the housing market recovers.

Main Street Capital, POZEN (NAS: POZN) , HFF (NYS: HF) , and Hi-Tech Pharmacal (NAS: HITK) just missed on the ROE requirement for the 2009 fiscal year.

POZEN is among those mentioned as an undervalued health care stock by Alexander Crawford -- stocks that have a low earnings multiple and are being purchased by institutions. Main Street, HFF, and Hi-Tech Pharmacal have appeared on my Foolish 8 screen in recent months and are definitely worth delving into, though you can see the volatility we're dealing with here.

MAIN Chart
MAIN Chart

MAIN data by YCharts

Onward and upward
I'm tracking and scoring each one of my monthly screens now. Altisource and SolarWinds remain the lone entries on the Modified Foolish 8 CAPS page. Add the page as a favorite to keep track of things along with me.

Also, make sure you balance your risky small caps with some large, solid, dividend-paying stalwarts. Find some of the Fool's favorites in our special report, "Secure Your Future With 9 Rock-Solid Dividend Stocks." It's available free, by clicking here.

At the time thisarticle was published Fool analyst Rex Moore tweets but is not a twerp. He runs a real-money portfolio based on his screens. He owns no companies mentioned here. 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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