Only 1 Stock Passes This Tough Screen

This article is part of our Rising Star Portfolios series.

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 eight candidates. Today, we turn to the Modified Foolish 8.

Mod squad
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, the Mod 8 has an average annual growth rate of 20.2% from January 1998 through May 2011. The S&P 500 averaged 2.5% annually over that period. (Disclaimer: 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. Still, this performance points to the screen's strong potential.)

Only one company passes the screen this month.

Company

Market Cap
(in millions)

Business

Add to Your Watchlist

LSB Industries (NYSE: LXU  ) $750 HVAC and chemical products Add

Source: S&P Capital IQ.

Hittite Microwave (Nasdaq: HITT  ) dropped off the screen from last month.

LSB is a diversified small cap with two main segments, climate control and chemical. Its agriculture chemical products place it in direct competition with fertilizer powerhouses Terra Nitrogen (NYSE: TNH  ) and PotashCorp (NYSE: POT  ) . I covered its latest earnings report in depth and came to the conclusion that the 15% sell-off was overdone. Digging deeper:

Company

InsiderOwnership

Forward P/E

EV/FCF (TTM)

ROE

Net Margin

LSB Industries 17% 40.0 21.5 35% 10%

Source: S&P Capital IQ.

Onward and upward
In the coming days, I'll take a closer look at LSB, as well as the small caps that passed yesterday's Foolish 8 screen. I'll soon report back on whether any of them are a good fit for the portfolio. So far, I've bought three stocks off these screens: LSB Industries, lululemon athletica (Nasdaq: LULU  ) , and Kulicke & Soffa (Nasdaq: KLIC  ) .

If you're interested in keeping up with any of these companies, add them to your free watchlist and gain access to The Motley Fool special report "Six Stocks to Watch from David and Tom Gardner."

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. Click here to see all of our Rising Star analysts (and their portfolios).

Fool analyst Rex Moore tweets but is not a twit. Of the companies mentioned here, he owns shares of lululemon. The Motley Fool owns shares of Kulicke & Soffa Industries, LSB Industries, and lululemon athletica. Motley Fool newsletter services have recommended buying shares of lululemon athletica. 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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