At the Motley Fool, we're looking for "the next Microsoft." That is, in our Motley Fool Hidden Gems service, we're trying to find a small-cap company that is good enough to grow by leaps and bounds over the years, giving outsized returns to Foolish investors.

One tool Andy Cross, co-advisor of Hidden Gems, and I have developed is this small-cap report card. (For a detailed description of how it works, read this guide.) With it, we get a sense of how good potential investments really are.

Today's subject: Sequenom (Nasdaq: SQNM).

It starts with management

Here's how the management section stacks up:

Metric

Trailing 12 months

Weighting

Score (out of 5)

Tenure, avg. CEO & CFO (years)

22.5

10%

5

Value of company owned, avg. CEO & CFO

$0.7 million

10%

0

Salary of CEO

$475,000

10%

5

CFFO > Net income (millions)

($49) vs. ($71)

10%

5

Source: Capital IQ, a division of Standard & Poor's, and company filings.

If you recall, Sequenom's great new product to test for Down syndrome (T21) turned out to have a bunch of false data behind it. The CEO and chief science officer were both sacked, and the CFO resigned. The new CEO, Dr. Harry Hixson, was chairman of the board before that and has been in the biotech field since he started working for Amgen 25 years ago. The new CFO, Paul Maier, has been a senior executive in biotech companies for 20 years. The only knock I have on management is their low ownership stake, but given their relatively new positions, I can't hold that too much against them.

It continues with competitive advantage
The company's lost money for quite a number of years -- hey, it's a development-stage biotech! -- but that's not my primary concern. Their big product, the T21 test, is not extremely difficult to duplicate. There are plenty of people out there with DNA-handling experience.

Metric

Trailing 12 months

Weighting

Score (out of 5)

ROC increase or steady?

(60.8%)

25%

2

Source: Capital IQ.

Don't forget the numbers
Here's how Sequenom shakes out:

Metric

Trailing 12 months

Weighting

Score (out of 5)

Debt / Equity

2.6%

10%

5

Operating margin

(157%)

10%

2

Revenue growth

1.1%

5%

3

Net income growth

N/M

5%

2

Free cash flow growth (millions, YOY)

($57.4) vs. ($39.5)

5%

2

Source: Capital IQ; N/M = not meaningful.
*Years ended 12/31/09 and 12/31/08

Remember, except for the D/E ratio, the score is how many years out of the last five each item grew over the previous year. The debt situation is excellent -- very low -- but the rest of it won't improve until it validates the T21 test.

Bonus section
An "ungraded" section lets us see how our company stacks up against some competitors in several of the metrics above:

 

Sequenom

Beckman Coulter (NYSE: BEC)

Illumina (Nasdaq: ILMN)

Luminex (Nasdaq: LMNX)

CFFO > Net income

(ttm & score)

($49) vs. ($71)

5

$610 vs. $149

5

$215 vs. $80

4

$24 vs. $22

4

ROC increase?

(ttm & score)

(60.8%)

2

8.6%

2

7.7%

3

3.1%

4

Operating margin

(ttm & score)

(157%)

2

12%

2

21.2%

4

8.1%

4

Free cash flow growth

(ttm, YOY & score)

($57.4) vs. ($39.5)

2

$255 vs. $265

4

$165 vs. $111

4

$13.3 vs. ($5.0)

3

Source: Capital IQ; ttm = trailing 12 months; dollar amounts in millions.

Of the four, Sequenom is obviously in the worst position. But Beckman has had trouble holding ROC and operating margin steady, as well. Illumin and Luminex score fairly well. Between the two, I'd have to give the nod to Illumina, both for its higher ROC and margin as well as for its stronger free cash flow.

Add it all up
With everything in, here's how Sequenom scored:

Weighting

Category

Final Grade

 

Management

 

10%

Tenure / experience

5

10%

Value of company owned

0

10%

Salary of CEO

5

10%

CFFO > Net income

5

25%

Moat

2

 

Financials

 

10%

Debt / Equity

5

10%

Operating margin

2

5%

Revenue growth

3

5%

Net income growth

2

5%

Free cash flow growth

2

100%

Total Score (out of 5)

3.05

 

Final Grade

B-

About what I expected, given the above. Aside from strong scores on management and its strong balance sheet, Sequenom doesn't score very high. Right now, it's a play on the ability to validate a successful T21 test. If it can do so, investors should do quite well. If it can't, watch out below. Risky, to the same extent that most biotechs are risky.

We'll check back after each quarter to see if it can bump it up a notch.

If you'd like to see how other small cap companies stack up, you can always take a free, 30-day trial to our small cap newsletter/real-money portfolio service, Motley Fool Hidden Gems.

Illumina is a Stock Advisor recommendation. Motley Fool Options has recommended a diagonal call position on Microsoft, which is a Motley Fool Inside Value pick. Try any of our Foolish newsletters today, free for 30 days

Fool analyst Jim Mueller owns shares of Sequenom and is a beneficial owner of Microsoft, but does not have a position in any other company mentioned. He works with the Stock Advisor newsletter. The Motley Fool's disclosure policy got straight A's.