High-Risk, High-Reward Small Caps

This article is part of our Rising Star Portfolios series.

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. Net profit margin: 7% or greater.
  4. Daily dollar volume: $1 million to $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, nine companies passed the screen:

Company

Market Cap (in Millions)

Business

Add to Your Watchlist

Altisource Portfolio Solutions

$1,263

Real estate management and development Add
CVD Equipment

$79

Semiconductors and semiconductor equipment Add
Fortinet (Nasdaq: FTNT  )

$4,113

Software Add
Gulfport Energy

$1,938

Oil, gas, and consumable fuels Add
Hi-Tech Pharmacal (Nasdaq: HITK  )

$520

Pharmaceuticals Add
Liquidity

$1,327

Internet software/services Add
MercadoLibre (Nasdaq: MELI  )

$4,204

Internet software/services Add
Ocwen Financial

$1,949

Thrifts and mortgage finance Add
SolarWinds (NYSE: SWI  )

$2,792

Software Add

Source: S&P Capital IQ.

MercadoLibre, the "eBay (Nasdaq: EBAY  ) of Latin America," frequently shows up on my screens. There may be some concern about eBay and others making inroads into its territory, but I'm a huge believer in the network effect. eBay must believe that also, because it bought up about 18% of MercadoLibre.

I passed on this stock a little over a year ago on valuation and accounts-receivable concerns. It's up about 35% since then, but what a wild ride it's been:

MercadoLibre is always on my watchlist, and I'll pay more attention if it suffers another big drop in the future.

Fortinet is appearing on my screen for the first time. This $4 billion firm provides network security and unified threat management (UTM) services to companies and government entities worldwide. The company recently blew away earnings estimates -- something of a recent habit. This seems to me to be a huge growth area, and Fortinet moves to my short list for further research.

Hi-Tech Pharmacal continues to intrigue me with high growth and relatively low multiples. Specifically, revenue and earnings have grown 38% and 52%, respectively, over the last 12 months, and the stock carries a forward P/E of 11. However, the four analysts providing estimates expect negative growth over the next few years. But for this company, it all depends on the development and approval of its pharmaceuticals. Expect wild swings.

SolarWinds capped off another year of strong growth by beating fourth-quarter estimates and jumping 10%. The stock is up nearly 75% over the past year, but to continue this outperformance it must successfully navigate its acquisition strategy and continue to grow past its traditional network management roots.

I hear CAPS calling
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 show you 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.

Fool analyst Rex Moore reminds you that time holds the winning hand. He owns shares of eBay. Motley Fool newsletter services have recommended buying shares of eBay, Mercadolibre, and Liquidity Services, as well as writing puts on eBay. 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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