The Foolish Eight
Finding Small-Cap Gems

For those of you who've read David and Tom Gardner's book The Motley Fool Investment Guide, you'll remember the chapter that discusses how our esteemed leaders pick some of the smaller cap stocks in their portfolio. In that chapter, they list eight criteria to look for in a small cap company. These criteria don't guarantee investment success, but they sure point you in the right direction. The recipe for success here is to find rapidly growing, financially healthy companies that as yet underfollowed by Wall Street.

Let's briefly examine the eight criteria:

1. Sales of less than $200 million. Among America's small cap companies"you're most likely to find an uncut gem."

2. Daily dollar volume of $3 million or less. All this means is that the average daily volume in the stock market times the stock price is less than $3 million. There is some leeway with this rule. If you find a stock with all the other seven criteria and dollar volume is $4 million, I don't think anyone will call the investing police on you :)

3. Low share price: between $5 and $20. Although they're not big sticklers on this point, Tom and David prefer stocks between $5 and $20, as our experience has been that these stocks rise more rapidly than those of higher share price.

4. Net profit margins of 10% or more.

5. Relative Strengthrate of 90% or higher (as listed in Investor's Business Daily). We want our companies' stock to be doing well.

6. Earnings and sales growth of 25%or more. In the most recently reported quarter, we want companies to have had increases of greater than 25% in both areas. No excuses here.

7. Insider Holdings of at least 15%. We want the people running the company to have a very large financial interest in the company doing well.

8. Positive Cash Flow. We want a company to be generating gobs of cash from its business.

That's all of 'em! Now that we have all the criteria, how in the world do you ever actually find companies that meet them? Homework. No two ways about it. You have to keep up with the earnings and revenues and financial statements and... and...

OR... you *could* ask your favorite investment resource in the whole-wide-world (that would be us) if maybe they could help lighten the research load just a bit for you. Perhaps provide you with a starting point.

Heaven knows you're willing to call the companies "after" you've identified them and request investor packages, but it's arriving there that takes SO much time. Well Fools, we're smart enough to see strong demand for something and we've risen to the occasion. Once every 6-8 weeks, the Industry Decathlon weekly report combs through the Nasdaq stock market to uncover these potential winners. We also take things one step further and run the PEG ratio on each stock. Not only do you get a list of potential winning small cap companies, but you also get a quick valuation for each. This helps you to find undervalued companies with strong potential. Finally, we give you the telephone numbers for each company so you call and get the investor's package. This three step process enables you to:

1.Identify potential companies.
2. See which are undervalued.
3.Contact the company and get more information so you can learn the whole story.

All of this comes in the Foolish Eight report.

Once you identify a favorite small cap, you can discuss it with your fellow Fools on our message boards.

© Copyright 1995-2000, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. The Motley Fool is a registered trademark and the "Fool" logo is a trademark of The Motley Fool, Inc. Contact Us