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Sonic Corporation (SONC), Cyberonics, Inc. (CYBX): Three Future Winners You Should Look At

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It can be hard to pick future winners. In fact, it is almost impossible to consistently pick small cap stocks that are destined for greatness. However, based on vigorous screening criteria, I have picked three stocks that I believe are destined for greatness, based on their current financial information.

I have been searching for future winning equities based on the following criteria:

Small market cap. – greater than $300 million but smaller than $2 billion.

Liquidity – the stock must have an average daily volume of 400k shares traded.

Sonic Corporation (NASDAQ:SONC)Sustainability – the company must operate in a sustainable industry; no cyclical stocks either. The company’s operations must be focused in a fairly stable industry with constant demand e.g. Healthcare, consumer defensive.

Return on shareholder equity – the company must have achieved average return shareholder equity of more than 10% over a five year period.

Debt – debt must be low and interest payments must be well covered.

Cash – the company must have cash on its balance sheet and the cash balance should be growing.

Cash flow – free cash flow must be strong over a number of years to remove the effects of one off items.

Solvency – the company must have good quick and current ratios.

History of increasing shareholder returns – through either buybacks or dividends.

So here are the candidates:

Cyberonics, Inc. (NASDAQ:CYBX)

Market Cap. $1.2B
Average Share Volume (per day) 500,000

Cyberonics is involved in the design and sale of implantable medical devices, a sustainable industry that is not effected by the economic climate or fashionable trends. A higher level of medical care around the world will require a larger amount of medical implants.

Cyberonics, Inc. (NASDAQ:CYBX) has achieved a return on shareholder equity of 20% on an average for the past three years, while the five year average is 109%. During 2012, the company produced a net income of $40 million on shareholder equity of $180 million. In addition, Cyberonics has a strong balance sheet with no debt, and large, positive shareholder equity.

$US MILLIONS 2009 2010 2011 2012
Cash and Short Term Investments $66 $59 $89 $97
Total Debt $62 $15 $7 $0
Net Debt -$4 -$44 -$82 -$97

For the past four years, Cyberonics has had a net cash position and the company paid off its last bit of debt in 2011.

$US MILLIONS 2009 2010 2011 2012
Net Operating Cash Flow $25 $43 $50 $75
Net Investing Cash Flow -$3 -$6 -$11 -$22
Free Cash Flow $22 $39 $46 $58
Issue/(reduction of debt) -$50 -$43 -$8 -$7
Stock buyback $1 $40

Cyberonics, Inc. (NASDAQ:CYBX) has a strong free cash flow, thanks in part to its 90% gross margin. The company has as free cash flow equivalent to about 80% of its operating cash flow for the past four years. This high margin gives plenty of room for dividends, stock buyback, or debt retirement.

$US MILLIONS 2009 2010 2011 2012
Current Assets $104 $115 $151 $161
Inventories $13 $14 $15 $14
Current Liabilities $18 $23 $29 $23
Current Ratio 6 5 5 7
Quick Ratio 5 4 5 6

There is a trend developing here. Cyberonics has a quick ratio of 6, and a current ratio of 7, which indicate that the company could pay off its liabilities falling due within 12 months seven times – more than enough.

The last criteria, shareholder returns is where Cyberonics, Inc. (NASDAQ:CYBX) falls down. The company does not pay a dividend, but it did buy back a small amount of stock during 2012. However, the share price has risen 270% over the last five years, and due to Cyberonics highly cash generative operations, I would not rule out future cash return to shareholders.

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