Color to the Numbers: Top High-Margin Growth Stocks

Thanks to the Internet and sites such as Yahoo! Finance and MSN Money, investors have more tools than ever to search for stock ideas. But screening stock databases often returns numerous stocks that need to be weeded out because the numbers don't tell the whole story. Maybe the massive growth at one company resulted from one-time tax adjustments, not core operations. Or maybe the screen didn't include the latest announcement that a dividend was canceled.

So just like the color-by-numbers books kids doodle on, the picture for stocks pulled from any screen isn't clear until the appropriate colors are added to the page. In this edition of "Color to the Numbers," we'll enlist Motley Fool CAPS to look at a screen for high-margin growth stocks.

Better a screen than a window
The knowledgeable investors who rate stocks in CAPS will help us. By pulling up a quote on a particular stock in CAPS, investors can see at a glance how the community rates a company today. In addition, investors can see how the very best All-Star stock pickers -- CAPS players with a ranking above 80 -- rate a given stock. There are even pitch commentaries and blogs that offer the details behind bull and bear opinions. This information gives investors many more qualitative resources than just numbers and tables.

Let's look at today's high-margin screen, using the following criteria:

• Market cap of at least $100 million;
• Gross margin of at least 80%;
• Trailing-12-month net margin of at least 15%;
• And estimated annual earnings growth of at least 15% for the next five years.

This should give us the cream of the crop in terms of stocks that have lean-and-mean business models -- those that earn high-margin revenue with good growth prospects. Of course, companies that bring a lot of cash to the bottom line tend to be pricey and sometimes volatile stocks, making qualitative analysis all the more important. This is where CAPS can really help.

Opinions with the numbers
Here's a sampling from the list of stocks our screen pulled up today.

It's interesting to see multiple companies with similar, highly profitable business models popping up on our screen. In this list, LoopNet, CME, and NYMEX all facilitate markets for buyers and sellers, while MicroStrategy and Applix provide business intelligence software and services. These industries tend to have sunk costs into infrastructure that scales well once it is built out, leading to very healthy operating margins once the company matures.

A recommendation in both the Motley Fool Rule Breakers and Motley Fool Hidden Gems newsletters, LoopNet also is a strong favorite in the CAPS community. A near-unanimous 1,286 out of 1,310 investors rating the online listing company believe it will beat the S&P, thanks to valuable software tools and services that are attractive to commercial real estate buyers and sellers. While the straw hut titled "subprime loans" and wood structure of homebuilders are quickly deteriorating and revealing little pink piggies inside, LoopNet's brick house built on commercial real estate continues to power earnings that surpass estimates quarter after quarter.

But relative immunity from housing woes is not all that CAPS investors like about LoopNet. High insider ownership, no debt, and an estimated growth rate of 30% are some reasons investors are willing to look past a forward P/E of 31. With LoopNet's success in dominating the commercial real estate niche, many investors also see the company as capable of becoming the next eBay.

A lean business model doesn't always go hand-in-hand with investor favor, however. While both Applix and MicroStrategy develop business intelligence tools and sport great margins, CAPS investors have more concerns about investing in MicroStrategy. Maybe it's just the ghosts of past revenue recognition "issues" that stick with investors, but nine of the 28 CAPS All-Stars rating the company think it will underperform the market going forward. Some investors voiced unease over the company's valuation, a concern that hit home when MicroStrategy reported lower earnings for the second quarter as net income dropped 30% from a year ago.

Let 60,000 investors be the judge
It may be difficult to discern just where opportunities lie with high-margin growth stocks, especially when you're just "running the numbers." Thankfully, the collective wisdom of a huge pool of investors can quickly add color to the outlines. But even with an entire community of qualified opinions acting as the judge, individual investors should still perform their own research.

Want to see your favorite screen results get run through the wringer in the CAPS community? It's free to tap the knowledge base and even give your own opinion. Check out Motley Fool CAPS for yourself.

The Rule Breakers newsletter service looks for companies like LoopNet with strong growth and a defensible moat. To see what stocks David Gardner is picking to beat the market today, take a free 30-day trial.

Fool contributor Dave Mock does his best to color within the lines, but he reserves his right to artistic expression. He owns no shares of companies mentioned here. Dave is the author of The Qualcomm Equation. NetEase and Applix are Rule Breakers recommendations, and eBay is a Stock Advisor selection. The Fool's disclosure policy doesn't see color or the wart on your nose.