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Greetings all. I am a new comer to the small cap investment strategy, but I have been reading about it at online and in "The Motley Fool Investment Guide". I have used the investment guide to list the rules for Selecting the Best Growth Stocks (Chapter 15 in the Investment Guide), but I have questions.

I am tracking a growth stock, but I have found that the net profit margin is less than the recommended 10% (if my calculations are correct the net profit margin for the stock is 7.8%). So my question is this, based upon collective experience should I follow the rules to the letter and disqualify this stock now, or do I proceed forward as I have found that, to date, this is the only criteria that does not meet growth stock selection considerations.

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Personally, I don't demand a particular profit margin. A higher one is better, but I don't have a particular cutoff. On the other hand, I do believe that it's better to disqualify a "marginal" stock than buy one that you're less than happy with. In your position, I would probably read through that section of the book again and decide if I thought the 10% criteria was crucial in light of what I knew about the company. (Is it in an industry with lower profit margins? Has the margin risen or fallen significantly?) Also, make a quick summary of the good and bad things about the company (beyond the criteria it satisfies or doesn't). What are the risks facing this company? How much do you think it's worth?

Another idea would be to just put this stock on hold and try to find something else that does meet the criteria exactly; you don't have to make a quick decision on any particular stock. That way you could get a better idea of what small cap opportunities are out there before putting money on the line.

If I may ask, what company are you considering?
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Ribbs, thanks for the reply. As for as the stock I am considering it is Medical Action Industries, Inc. (MDCI). It is a hidden gem, per Thomas Engle (

If you wouldn't mind evaluating with me I would like to compare my research against yours to determine if I am executing the growth stock selection criteria correctly.

Let me know if you are interested in being a mentor for a day.

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The article on MDCI caught my eye as well so I'll share a couple of observations. Before putting too much faith in what I have to say, though, you should know that I'm also relatively new to investing (particularly small cap investing) and that I haven't fully examined the company. I also don't have time right now for a really thorough look.

If you want a comparison against the criteria in the Motley Fool Investment Guide, you'll need to post them. I think I've read the book (that's one of their earlier ones, right?), but don't have it. (I get most of my investment books from the library...)

One thing to keep in mind with small cap investing is that the stocks can be very volatile. The article on the Fool seems to have moved the stock from ~16 to ~18. The stock could decide to drop to 16 (or below) on no news in particular and actual bad news could give quite a drop in price. On the plus side, of course, the stock could rise for no particular reason and may gap up on good news. I definitely recommend that you hold small caps as part of a larger portfolio.

Now for the company itself...
Gross margins seem to be trending down (29.9% and 30.8% for the last two years, but less than 27% for the last two quarters...) but net margins seem to be holding up pretty well (13.3% and 12.5% for the last two years, 12.6% and 12.3% for the last two quarters). I don't think the margins would vary seasonally for medical supplies, but that would be something to check in the quarterly press releases.

One of the main things I look at is the free cash flow. This company makes minimal capital expenditures. Cash from operations is quite choppy, but seems to be always positive. The last four quarters have all been good so that the P/CF ratio is ~9 (just stealing the ratio from the Snapshot part of the quote on the fool; this isn't always accurate). Have the last quarters been better than the past for a reason that will continue? (like an aquisition that's going well) A rule of thumb is that the multiple should be approximately the growth rate; if the recent growth rate continues, the company is worth nearly twice its current price. (Note that this assumes that the last 4 quarters are representative; less rosy assumptions lead to a lower valuation.) The other consideration is the use of cash for acquisitions. Cash being used this way doesn't go to shareholders so you have to believe that the acquisitions are being made at good values.

Based on this quick look, I think MDCI is worth further research and I would seriously consider buying it. Before actually buying, I'd suggest that you read the most recent annual report and a couple of quarterly reports. In particular, see if there is an explanation for the choppy results. (Choppy results are pretty common for small companies, but they do make for more guesswork to find trends.) Also, how many options is the company issuing? How is their debt financed?

Let me know what you find. I'll probably follow up on this stock more as well.
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