Thanks to the Internet, and sites such as Yahoo! Finance and MSN Money, investors have more tools than ever to search for stock ideas by running screens. 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, not core operations, for instance.

Just like the color-by-numbers books kids doodle on, the picture for stocks pulled from any screen isn't clear until we add the appropriate hues. 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
In CAPS, investors can see how the community rates a company and can compare that rating with the opinions of the very best All-Star stock pickers -- CAPS players with a ranking greater than 80. There are even pitch commentaries and blogs to lend detail to the bull and bear opinions.  

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%.
  • 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. Of course, these companies tend to be pricey, making qualitative analysis all the more important. This is where CAPS really helps.

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


Net Margin

CAPS Rating (out of 5)

China Mobile (NYSE:CHL)



Adobe Systems (NASDAQ:ADBE)



Chesapeake Energy (NYSE:CHK)



Genentech (NYSE:DNA)



Red Hat (NYSE:RHT)



High on China
High margins are often associated with software companies, but our list today shows a broad spectrum of industries: communications, energy, biotechnology. While it's also common to see biotech companies sporting very high margins once a drug has been developed and marketed, it's not often you see a wireless service provider delivering 23% net margins. But China Mobile, the largest wireless services provider in China, has managed net margins in excess of 20% in all but one of the last 10 years.

China Mobile's secret sauce for high margins comes partly from its dominant position in the People's Republic of China, with competition for wide-area wireless services coming only from much smaller China Unicom (NYSE:CHU). Its massive size also gives the company significant "economies of scale," akin to Wal-Mart, allowing it to command lower purchase prices on equipment due to its high volume.

As mentioned previously, though, high-margin cash cow companies tend to have high multiples priced into shares, and China Mobile is not a bargain at its current price. With a forward P/E of 23 slightly ahead of its expected 22% growth rate, many CAPS investors still favor this mobile leader. But the company's long-held five-star rating has given way to a four-star rank as more investors are calling the stock overvalued.

Money for free
Open-source software solution provider Red Hat also makes the high-margin list, thanks to more and more consumers and enterprises embracing Linux and other alternative software platforms. Often seen as the Microsoft and Oracle (NASDAQ:ORCL) alternative, Red Hat leverages the disdain and frustration many enterprises experience with "traditional" suppliers of operating systems and applications as well as the open nature of its solutions to offer attractive solutions.

The low cost and flexible nature of Linux coupled with its emergence as more than just a hobby in the enterprise realm has been fueling profits for Red Hat lately. Surprisingly, many investors don't believe that a business model based on sales of open-source software is sustainable, and a full 25% of CAPS All-Stars expect Red Hat to underperform the market in the future.

Let 74,000 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.

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. Chesapeake Energy, Microsoft, and Wal-Mart are Inside Value recommendations. The Fool's disclosure policy doesn't see color or the wart on your nose.