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

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.