Small-cap investing is about looking under a lot of rocks, in hopes of occasionally finding a grub. This past week, I may've found a tasty one in AmSurg (Nasdaq: AMSG), the country's leading single-specialty surgery center company.

AmSurg came to my attention when I saw that it met seven of our eight Foolish small-cap criteria. The only criteria it falls short on is the 10% inside-ownership minimum; AmSurg's insiders own just 3.3% of the company. But on all other fronts, the company sails past our Foolish 8 criteria.

In 2001, the company generated $203 million in revenue, up 41% from the prior year. Net income followed suit with 64% growth, although due to a secondary offering of stock last year, earnings per share (EPS) grew at a somewhat slower rate of 30%. Profit margins were strong at 7.4%, up one percentage point from the prior year, and exceeded our 7% Foolish 8 hurdle. Meanwhile, operating cash flow was exceptionally strong at $37 million, or 18.3% of sales. Even after deducting capital expenditures, free cash flow amounted to 15% of sales.

Based in my hometown of Nashville, AmSurg operates a fast-growing base of outpatient surgery centers. The company was formed in 1992 and went public in late 1997. After the IPO, the stock drifted along in the single-digits through the middle of 2000, but over the past two years, the stock is up 370%, including a 27% performance over the past 12 months. Apparently, investors finally took notice of the fact that for each of the past 16 quarters since going public, AmSurg has produced new records in revenues, net earnings, and same-center revenues. Much of this growth is coming organically as the company has achieved double-digit same-center revenue growth for each of its four years as a public company.

As of the end of last year, AmSurg owned a majority interest in 95 surgery centers in 27 states and the District of Columbia. The company's competitive advantage comes by providing a narrow range of high volume, lower-risk surgical procedures. Most of the company's surgery centers are equipped and staffed for a single medical specialty, the primary ones being gastrointestinal endoscopy (57 centers), ophthalmology (32 centers), and orthopedics (2 centers). The company targets these medical specialties because they are relatively low-risk and quick operations, thus allowing for a high volume of procedures during any given day. Additionally, by focusing on a single specialty, each surgery center is able to operate at significantly lower capital and operating costs compared to hospitals or other multi-specialty outpatient surgery centers.

One final advantage worth mentioning is that AmSurg's specialty centers are generally located adjacent to or in the immediate vicinity of the practicing physicians, thereby making this type of practice an attractive option to physicians. Compared to hospitals, which are less efficiently run and in all likelihood less conveniently located, these specialty centers allow a physician to maximize his or her productivity.

From an industry perspective, AmSurg has the wind at its back thanks to a healthcare environment focused on cost containment. Healthcare payers (government programs, insurance companies, etc.) are happy to direct patients to AmSurg's specialty surgery centers as opposed to more-expensive inpatient hospital care. In addition, new technology is expanding the types of surgical procedures available for performance on an outpatient basis. Advances in anesthesia, along with the use of lasers, enhanced endoscopic techniques, and fiber optics, are all helping to reduce the recovery time associated with many surgical procedures. Quicker recovery time reduces treatment cost by eliminating the need for overnight hospital stays.

With growing demand for the more cost-effective solution provided by AmSurg's specialized surgery centers, the company is focused on growing its base of centers, currently at 95 locations, up from 39 at the end of 1997. New surgical centers come through internal development (in partnership with physicians) and acquisitions of existing practices. AmSurg's ownership interests are primarily structured through limited partnerships or limited liability companies in which AmSurg owns 51% to 67% of the equity. Under this format, AmSurg receives a percentage of the net income and cash distributions equal to the percentage ownership interest. The percentage interest not owned by AmSurg is paid out in the form of minority interest.

As an overall economic entity, the specialty surgery center model produces very attractive results. Last year, return on invested capital (ROIC) was 20.5%, up from 19.6% in 2000 and 18.9% in 1999. But because of the substantial minority interest payouts, which have amounted to 62% of operating income on average over the past five years, the net income that accrues to shareholders produces a return on equity (ROE) much lower than ROIC. Last year's ROE was 11.1%. In other words, AmSurg's minority interest beneficiaries (primarily the partnering physicians) reap a substantial portion of the economic value created.

Nevertheless, AmSurg represents an interesting opportunity. The stock currently trades for around 19x free cash flow and 38x earnings. (Earnings are artificially depressed by heavy non-cash amortization expenses that have resulted from past acquisitions.) The current price may not prove to be a bad one if management delivers on its goal of 17% - 20% revenue growth and 22% - 25% EPS growth for 2002. The bullish management team is already anticipating additional 22% - 25% EPS growth for 2003 and 2004, as well. Based on the mid-range EPS guidance (which excludes the effects of amortization) for 2002, the stock is currently trading for 25x forward earnings.

To be conservative and also to allow for the inevitability of slower growth, I would anticipate nothing higher than a 20% EPS growth rate over the next five years. This would be no small feat, but clearly within the sights of this hard-charging company. Based on a 20% EPS growth assumption, I wouldn't want to pay a forward multiple any higher than the growth rate. At 20x the forward estimate of $1.13 per share, that would be a stock price of $22.60, about 18% below the current price. With the company's momentum, the stock might not drop to those levels, but if it did, that's when I'd revisit the stock for consideration. For the time being, keep AmSurg on your small-cap radar.

Matt Richey is a senior investment analyst for The Motley Fool. He welcomes your feedback at MattR@Fool.com. As for surgery, he doesn't mind it one bit (and even secretly admits to enjoying it) as long as the anesthesia is cranked up. At the time of publication, he had no position in AmSurg. Matt's personal portfolio is available for viewing within his profile. The Motley Fool is investors writing for investors.