Natus Medical vs. Under Armour: Natus Medical

In the competitive spirit of college basketball's annual championship tournament, The Motley Fool brings you Stock Madness 2007! Our writers are making head-to-head arguments for their chosen stocks (but not necessarily investment recommendations -- this is, after all, a game), and you'll pick the winners with your article recommendations and Motley Fool CAPS ratings. Who will win the right to cut down the net? Let's tip things off and find out!

Here are five traits of the market's best stocks:

1. Small.
2. Cheap.
3. Led by dedicated management.
4. Fiscally conservative.
5. Dominant positioning in a profitable niche.

That description has characterized some of the market's biggest winners over time, including Dell (Nasdaq: DELL  ) , Wal-Mart (NYSE: WMT  ) , and Microsoft (Nasdaq: MSFT  ) .

Now, here are five traits of Natus Medical (Nasdaq: BABY  ) :

1. Small.
2. Cheap.
3. Led by dedicated management.
4. Fiscally conservative.
5. Dominant positioning in a profitable niche.

Shall we go on?

Yes, let's!
With Natus Medical, you're getting a $330 million health-care equipment company that's fast becoming the main provider of treatment and screening products for newborns. (Hence the clever ticker.) Recent acquisitions have helped the company expand its line to encompass everything from hearing tests to jaundice treatments to oxygen delivery hoods.

In other words, Natus Medical is the very definition of a small company with dominant positioning in a profitable niche.

What's more...
As for management, all you need to know is that since acquisition specialist Jim Hawkins came on board in April 2004, the stock is up nearly 300%. Even better, David Nierenberg's activist D3 firm owns an 18% stake in Natus. As an outside shareholder, you can expect him to keep an eye on operations for you.

So now, you probably want to know: Is Natus cheap and fiscally conservative? Neither fact is entirely obvious from a look at the company's filings. But you don't make money in the stock market from the entirely obvious.

See, Natus Medical completed three acquisitions for a little more than $90 million over the past year. Those expenditures have strained the balance sheet, and integration costs have depressed earnings. By how much? It's hard to know.

But it is safe to say that last year's $0.05-per-share loss is misleading. These acquisitions have each been accretive in nature, helping Natus Medical expand its dominance within its niche. When the integrations are complete, and Natus can focus on bottom line, shareholders should expect to see earnings pop.

What the future holds
In fact, the company recently forecast 2007 full-year earnings of $0.49 to $0.52 per share. That would put Natus at a forward P/E of approximately 30. I won't say that's necessarily cheap, but remember that up until now, Natus has aimed to establish a dominant position within a profitable niche. Going forward, that positioning should help the company increase pricing power, and with it, margins.

As long as we have faith that management knows what it's doing, hasn't overpaid, and will deliver results as soon as the company is consolidated and firing on all cylinders, we have a stock that fits the profile of a small-cap buy.

But don't take my word for it. No less than David Nierenberg -- a master small-cap investor with 18% annualized returns over the past 10 years -- has called this a $40 stock over the next few years.

Speaking of $40 stocks, you know what else will claim that title over the next few years? Under Armour -- the stock that BABY, with your help, will bounce in the first round of this Stock Madness tournament. Simply follow this link and rank BABY "outperform" in Motley Fool CAPS. If you disagree, vote it "underperform." Later this week, we'll tally your votes to determine which stocks will advance one step closer to the title.

Read our opposing entry on Under Armour, or see all the entries in this tournament.

Think you could pitch your favorite stock -- or ditch your least favorite -- in 27 seconds or less? That's what we're doing over at Motley Fool CAPS. Check out our new stock videos.

Tim Hanson does not own shares of any company mentioned. Dell, Wal-Mart, and Microsoft are Motley Fool Inside Value recommendations. Dell is also a Stock Advisor pick. Under Armour is a Rule Breakers selection. The Fool's disclosure policy believes strongly that Billy Packer should call it a career already.