Finding the Next Big Stock

It's a question that haunts investors: "How did I let that stock get away?"

We all have our own story. Many times, the stock was sitting right under our noses, and we talked ourselves out of making an investment. Such mistakes can be discouraging, to say the least.

The important thing is not to give up searching for the next big stock. Motley Fool CAPS can help. Our new stock screener, combined with the opinions of more than 110,000 investors participating in CAPS, can help you whittle down the list of potential winners.

It's a simple equation
In the short term, the market is unpredictable. In the long run, however, the market rewards companies that:

• Consistently increase shareholder value.
• Grow more quickly than their peers do.

For example, in 1972, Wal-Mart was a tiny retailer with 51 stores in five states. It had plenty of room to grow, and over the next five years, Wal-Mart began to show signs that it was going to be a major player:

Source: Wal-Mart annual reports.

Wal-Mart's promise was difficult to miss. Not only was it expanding rapidly, but it was also generating solid returns on investors' equity year after year. Over the next 32 years, Wal-Mart sustained that performance in its business and generated 25% annualized returns for investors -- enough to turn a $1,000 investment in early 1976 into more than $1 million today.

So let's try it
Using the CAPS screener, I searched for highly rated small companies (less than $1 billion) that possess traits similar to what Wal-Mart had in its youth:

• Return on equity greater than 15%.
• Insider ownership greater than 10%.
• Three-year annual earnings growth greater than 15%.

Here are a few of the results:

Data from Motley Fool CAPS as of June 13.

These stocks appear to be promising, but this is not a list of formal recommendations. Instead, use it as a starting point for further research.

Do they have what it takes?
If you're looking to score a big winner, small caps are the place to start your search, but this segment of the market is also fraught with potential pitfalls. Before making any investment in a small cap, you should learn as much about the company as you can. To get you started down this path, let's see what some CAPS investors are saying about these stocks.

Smith & Wesson
The past eight months have not been kind to the handgun specialist. Shares sit a staggering 76% off their 52-week highs, but CAPS player JaegerGator thinks investors should take a longer-term perspective here:

S&W is undervalued [because of] some short term issues. Demand for S&W's firearms, long-term, will increase rather than decline. More military contracts will continue to roll in. Their glut of inventory will be sold, and they will recover.

Atrion
The Texas-based maker of medical instruments and supplies got some love from player in April from shaneconnerly, who proclaimed:

This stock will outperfrom the S&P 500. The company is growing at a steady rate and … insider buying has picked up in the last couple of weeks. The stock [also pays] a great dividend [currently 0.9%] with very little movement in the market.

The stock has traded pretty close to the S&P 500 since this player's pick was made.

General Steel
The China-based operator of a portfolio of steel companies sits more than 50% off its 52-week high, but back in March, mojotronic argued that "[a]side from carrying some debt, GSI has a solid base of business relationships and a huge market hungry for its products." It's important to note that, despite its recent decline, General Steel has still risen 153% over the past year.

DXP Enterprises
Shares of this 100-year-old Houston-based distributor of industrial products, services, and equipment have had a volatile year, but they remain close to the same price as last July, when rd80 made this comment: "DXP has a forward [price-to-earnings ratio] of 13.7 [and] estimated earnings growth next year of 20%. They just finished a secondary offering in early June and expect to use the proceeds to pay down debt and put some money in the coffers, possibly for acquisitions."

Credo Petroleum
Credo Petroleum shareholders have to be thrilled with the stock's performance thus far in 2008 -- it's up 50% year to date. Record oil prices have had something to do with that, but Sentineneve noted this company's strong management, patents, and healthy balance sheet as reasons to give Credo a second look. Sentineneve's pick has outperformed the market by 40 percentage points over the past five months. Not too shabby.  

What do you think about these stocks? Do you disagree with their ratings? CAPS' 110,000 investors are waiting to hear what you think. So sign up today. CAPS is 100% free, and it's guaranteed to educate, amuse, and enrich.