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.
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.
