Color to the Numbers: Top Small-Cap Value Stocks

Thanks to the Internet and sites such as Yahoo! and MSN Money, investors have more tools than ever to search for stock ideas by running screens of stock databases. But screens often return numerous stocks that need to be weeded out because the numbers don't tell the whole story. Maybe the massive growth at one company was due to one-time tax adjustments and 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 that kids doodle on, the picture for stocks pulled from any screen doesn't become clear until the appropriate color gets added to the page. In this edition of "Color to the Numbers," we'll enlist Motley Fool CAPS to take a Foolish look at a screen for small-cap value stocks, to see which ones may be worth investigating further and which should be cast aside.

Better a screen than a window
The community of knowledgeable investors who rate stocks in CAPS will help us in our search for small-cap value stocks. By pulling up a quote on a particular stock in CAPS, investors can see at a glance how the collective community rates a company today. Additionally, 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 give details behind bull and bear opinions. These tools give investors many more qualitative resources than just numbers and tables.

So let's take a look at our value screen for today and a handful of the top stock candidates it returned. To run this screen, we'll use the following criteria:

• Market cap between $100 million and $1 billion.
• A debt-to-equity ratio of less than 0.5.
• Free cash flow of at least $5 million.
• A projected five-year earnings growth rate of at least 15%.
• A forward price-to-earnings ratio of less than 15.

This should give us the cream of the crop in terms of small companies on a solid foundation with decent expectations for earnings growth. The debt-to-equity ratio and free cash flow hurdle will clear out companies that are more leveraged and aren't yet generating at least a minimal level of free cash. The earnings growth and forward P/E criteria combine to give us a forward-looking PEG ratio (the forward P/E divided by the estimated growth) of less than 1 and will help sift out only those stocks trading at a reasonable value. But the PEG alone doesn't dictate the value of a company or make it a good investment. (Hint: 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.

While not the cheapest of the bunch in terms of just numbers, First Cash Financial shows up as one of the top stocks on our screen today and one that the CAPS community highly favors. The pawn-store operator and consumer-loan provider has an exceptional growth record and outlook that made it a strong candidate for the best financial stock for 2007. Rapid growth in revenue from its retail operations in Mexico and a new entry into the profitable business of selling used autos has many investors singing the praises of the company. Collectively, more than 98% of CAPS investors are betting the company will beat the market going forward.

On the flip side, our screen of numbers shows what should be a screaming buy on ExpressJet, based on an ultra-low forward P/E and tremendous cash flow that is almost 25% of the firm's overall market capitalization. But the numbers don't tell the whole story with ExpressJet -- while many investors see a regional airline with a highly profitable track record, some CAPS investors are a little weary of the company.

ExpressJet is currently transitioning some of its fleet out of a capacity purchase agreement (CPA) with Continental Airlines' (NYSE:CAL), in which the company supported Continental Express routes with negotiated 10% operating margins and fixed fuel costs. The risks associated with being a more independent airline, combined with a rate dispute with Continental, have seven of the 61 CAPS All-Stars, as well as both Wall Street analysts with an opinion on ExpressJet in CAPS, giving bearish votes to the company. But with shares beaten down more than 25% so far this year, some contrarians are circling ExpressJet looking for an opportunity.

A very different company that never got off the ground with CAPS investors is Kansas-based MGP Ingredients. The producer of ethanol and other grain-based products always seems to be tied to speculative and newsy trends -- first, the low-carb rage a few years back, then the recent pet-food contamination findings, and now the buzz about ethanol-fueled cars. But even with associations to bubbly trends, the company is profitable and has been growing operating cash flow consistently over the past several years. While almost 50% of CAPS players giving an opinion on the company are bearish, this Fool is inclined to look a little closer at the company, particularly if the stock continues to drop.

Let 60,000 investors be the judge
The collective wisdom of a huge pool of investors can quickly add color to a whitewashed page of numbers. But even with an entire community of qualified opinions acting as the judge, individual investors are still the jury and should perform their own research.

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

Scouring the market for small caps with strong fundamentals and great potential is what the Motley Fool Hidden Gems newsletter service is all about. To see what stocks lead analysts Tom Gardner and Bill Mann picked this month, check out 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. The Fool's disclosure policy doesn't see color or the wart on your nose.