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: YRC Worldwide (Nasdaq: YRCW)

It starts with management
Here's how the management section stacks up:

Metric

Trailing 12 months

Weighting

Score (out of 5)

Tenure, avg. CEO & COO (years)

20.5

10%

5

Value of company owned, avg. CEO & COO

$0.1 million

10%

0

Salary of CEO

$928,000

10%

5

CFFO > Net income (millions)

($149) vs. ($323)

10%

5

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

Considering that the company is pulling back from the brink of bankruptcy, I'm surprised this section is as good as it is. You'd think with more than 40 years' experience in the industry between them, William Zollers (CEO since 1999) and Mike Smid (brand new COO, after several other management positions) would not have let the company get into so much trouble. And the miniscule amount of the company they own (management as a group owns 0.09%) is not encouraging at all.

It continues with competitive advantage
Return on capital had been pretty good at 10% to 12% for a while. Then, in 2007 it started to nosedive. The moat wasn't as strong as management thought, apparently, as the U.S. entered into recession. A company with a really strong moat often manages to keep things going when times go bad.

Metric

Trailing 12 months

Weighting

Score (out of 5)

ROC increase or steady?

(17.4%)

25%

1

Source: Capital IQ.

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

Metric

Trailing 12 months

Weighting

Score (out of 5)

Debt / Equity

678%*

10%

0

Operating margin

(7.6%)

10%

1

Revenue growth

(33.2%)

5%

2

Net income growth

N/M

5%

2

Free cash flow growth (millions, YOY)

($172) vs. ($246)

5%

1

Source: Capital IQ; N/M = not meaningful.
*For the year ended 12/31/09.

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. That D/E ratio is a result of the equity being wiped out by losses over the last couple of years. The company's carried a significant debt load. In 2005, it was just shy of $1.5 billion. Today, it stands at $1.16 billion, so it's moving in the right direction, but getting control of the situation will be a drag on the company for quite a while to come.

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

Metric

YRC Worldwide

FedEx (NYSE: FDX)

United Parcel Service (NYSE: UPS)

Echo Global Logistics (Nasdaq: ECHO)

CFFO > Net income

(ttm & score)

($149) vs. ($323)

5

$3,148 vs. $1,148

5

$5,285 vs. $2,152*

5

($5.5) vs. $7.6

1

ROC increase?

(ttm & score)

(17.4%)

1

7.9%

2

17.3%

2

9.1%

4

Operating margin

(ttm & score)

(7.6%)

1

5.8%

2

10.3%

1

2.7%

3

Free cash flow growth

(ttm, YOY & score)

($172) vs. ($246)

1

$322 vs. $294

2

$3,683 vs. $5,790*

2

($9.8) vs. ($6.9)

2

Source: Capital IQ; ttm = trailing 12 months; dollar amounts in millions.
*For the years ended 12/31/09 and 12/31/08.

Being big in the shipping business helps a lot, as FedEx and UPS show. That's part of the problem at YRC Worldwide is that they have to compete against those two, along with other shipping companies. And while these two also have large debt loads on an absolute basis, they also have the means to service it, with interest coverage ratios in the double digits. The last time YRC's was that high was back in 2005.

As for Echo Global, the apparent reason CFFO is perennially less than net income is because it's letting accounts receivables pile up. Not a good sign.

Add it all up
With everything in, here's how YRC Worldwide 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

1

 

Financials

 

10%

Debt / Equity

0

10%

Operating margin

1

5%

Revenue growth

2

5%

Net income growth

2

5%

Free cash flow growth

1

100%

Total Score (out of 5)

2.10

 

Final Grade

C

In this case, "C" does not mean "average." YRC has only just pulled itself back from the brink of bankruptcy and its auditors gave it a "going concern" rating for its latest annual report. Despite its soaring stock price recently, I'd stay away from this one. There are plenty of opportunities elsewhere.

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.

Microsoft is a Motley Fool Inside Value pick. FedEx is a Motley Fool Stock Advisor selection. United Parcel Service is a Motley Fool Income Investor pick. Motley Fool Options has recommended a diagonal call position on Microsoft. Try any of our Foolish newsletters today, free for 30 days.

 

Fool analyst Jim Mueller 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.