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Functionally Inspired - MicroCap Investor by Josh Levine

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America's Best "Small" Companies - According to Forbes
By Josh Levine -- November 15, 2010
Magazines, television and other media could not survive without their "best-of" lists, and Forbes magazine is among those who make ample use of this marketing ploy. From the "Fortune 500" to David Letterman's nightly "Top-10 List" to People magazine's "Most Beautiful People," Americans can't seem to get enough lists.

For as long as I can remember, Forbes has produced its annual "America's Best Small Companies and it's always fun to see how many companies I recognize on the list.

Going through the 200 companies this year it's shocking to see how few actual small companies make the grade. By definition most small publicly-traded companies should be microcaps with market capitalizations below $300 million. And the fact is two-thirds of all U.S. businesses have less than 10 employees.

Yet of the 200 stocks among Forbes' best small companies there are merely 5 microcaps, or 2.5% of the list. For any investor hoping to cull the list for new microcap ideas, you'll be disappointed.

Forbes first used a filter with these parameters to compile the candidates:

•Publicly traded for at least one year.
•Annual revenue between $5 million and $1 billion.
•Minimum stock price of $5.


Then it ranked companies based on earnings growth, sales growth and return on equity in the past 12 months and over five years. Forbes also factored in the stock performance of each company compared with its peers.

Once we see how Forbes arrived at the list, it becomes clear why so few microcaps showed up. By the time a small company has racked up five consecutive years of strong sales, earnings and ROI growth, it will invariably have matured enough in the market to become a small-cap player and moved well beyond the microcap realm.

Because the Forbes list relies on a few fundamental financial measures, it necessarily excludes nearly every small company developing advanced technologies and whose primary assets may be intangibles such as intellectual property and critical employee know-how. There's nothing wrong with this bias, as long as Forbes' editors would explain the limitations of its process.

I have a suggestion for Forbes the next time they publish this list. How about calling it "America's 200 Best Companies With Sales Below $1 Billion That We Could Uncover Using a Limited Range of Financial Parameters." Not quite as catchy, but definitely a better reflection of the list.
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