One of the things I enjoy most about my profession is doing deep research on superstar stocks to see what they all have in common. In "Six Signs of a Winner," Motley Fool co-founder Tom Gardner and I wrote about the winning characteristics of Progressive Insurance, which had been a 60-bagger over the past 17 years, turning a $5,000 investment into $300,000.

Today, I'll share one of the most interesting and profitable bits of research we've done. In broadening our study, we found seven commonalities of small-cap superstar winners. I'll talk about these, and reveal the only nine stocks that have every attribute.

The screening process here is actually very interesting. I started with all companies on major U.S. exchanges that have a market cap of at least $200 million. That's 3,545 companies. Then I screened for:

1. Double-digit rising sales
We view this as one of the most telling indicators of a real growth company. We love earnings growth as well, but earnings are too easily manipulated. Revenue growth, however, is a pretty pure marker of rising demand and pricing power.

It's been a tough year, and this requirement cut out biggies like Johnson & Johnson (NYSE: JNJ) and IBM (NYSE: IBM) -- both of which saw slight revenue dips. Of the companies we started with, only 853 grew revenue 10% or more over the past year (the time period I used throughout the screening process).

2. Rising free cash flow and book value
While earnings can be fudged, cash is where it's at -- and great businesses generate lots of it. A company that's growing both its free cash flow and book value is on the right track. We're down to 206 companies.

3. Improving margins
It's getting tougher now, but we're looking for excellence. The ability to take in more and more profit from each dollar of sales is an indication of competitive advantages and efficient management. I screened for improving margins from continuing operations, and that cut it to 121 companies. Here, we say goodbye to True Religion Apparel (Nasdaq: TRLG), but we have lovely parting gifts!

4. Rising return on equity
We use ROE as a decent proxy for how well a company allocates capital -- what Warren Buffett calls the most important aspect of management. And, once again, we're interested in improvement over the last 12 months. lululemon athletica (Nasdaq: LULU) and Shanda Games (Nasdaq: GAME) are among those that missed the cut here. Both still have fine ROEs -- 30% and 74%, respectively -- but the trend is what we're interested in. We're down to 99.

5. Insider ownership
This one's no surprise to all you veteran Fools out there. As shareholders of a company, we are part owners of the business, and we'd like a significant portion of management to be our co-owners. That way there's more incentive for them to act in our best interests. I always look for insider ownership of 5% or more. We lost a lot of companies this time, including Visa (NYSE: V) which is 0.1% owned by insiders. Now we're left with 40.

6. Regular dividends
There's research out there that indicates dividend-paying companies tend to be better at managing capital and growing earnings. We feel that the pressure of making quarterly cash payments forces a certain discipline on managers, and deters them from such destructive habits as "empire building" -- that's when companies in search of something to do with their cash start making less-than-ideal acquisitions. This screen requires a dividend yield of greater than zero, so even small payers can get by. Thirty-one others miss the cut here, and we're down to our final nine.

The envelope, please
Here are the only companies that passed every requirement of my screen:


Market Cap (Millions)

Insider Ownership

Price Change (1 Year)

DeVry (DV)




Silicon Precision Industries (SPIL)




Buckle (BKE)




E-House Holdings (NYSE: EJ)




Cubic (CUB)




Monro Muffler Brake (MNRO)




City Telecom HK (CTEL)




Meadowbrook Insurance Group (MIG)




First Mercury Financial (FMR)




Data provided by Capital IQ, a division of Standard & Poor's.

A common-sense disclaimer is required here: Screens such as this provide a great starting point for further research, but these companies are not formal recommendations.

Seventh heaven
"Now wait," I hear you saying. The title says seven signs of a winner." You are correct, oh eagle-eyed reader. The seventh attribute Tom and I found was "out-of-the-way success." Many big winners come out of relative obscurity, and are never media darlings or hot IPOs. That's rather hard to screen for, but that's OK: It seems the companies that made the final list aren't exactly bantered about at many cocktail parties anyway.

Our analysts at Motley Fool Hidden Gems run hundreds of companies through these criteria -- and more, including valuation -- every month. So far, the team has identified 10 small-cap stocks they think you should buy right now. For the next 30 days you can see them all, with full access to the Hidden Gems service, free of charge. Here's more information.

This article was first published on Feb. 11, 2010. It has been updated to reflect the latest screening results.

Fool analyst Rex Moore contributes the Foolish 8 screens to Hidden Gems. He owns shares of Johnson & Johnson. Cubic is a Motley Fool Stock Advisor selection. Johnson & Johnson is a Motley Fool Income Investor pick. Motley Fool Options has recommended a buy calls position on Johnson & Johnson. The Fool has a disclosure policy.