There are 5,586 small-cap stocks that trade on a major exchange right now. But you should only consider investing in six of them.

Two days ago, I ran my favorite screen looking for solid small-cap companies worth owning right now.

Year-to-date months, the companies I have recommended from this (and a similar) list are up an average of 21% so far. But I expect that number will continue to grow. You see…

Unlike many small-cap companies, these all have solid business plans. They are all making money. They are generating cash from operations. They have little (if any) debt, tons of cash and, most importantly, they have gotten stronger and stronger over the last three-five years.

Each company on this short list had to have:

1. Positive cash flow in each of the last 3 years.
2. Rising net income in each of the last 2 years.
3. Rising net profit margins in each of the last 5 years.
4. Revenue growth in each of the last 5 years.
5. More cash than total debt.

Over time, these are exactly the kinds of companies that will make shareholders wealthy. So without further ado, here are the only six companies that currently meet all five wealth-generating requirements:

Diodes Inc. (DIOD:NASDAQ): DIOD is a global supplier of semiconductor products for advanced electronic devices including digital audio players, notebook computers, flat-panel displays, mobile handsets, digital cameras and set-top boxes.

DIOD has generated $102 million in cash from operation over the last three years. Its net income has increased from $5.8 million to $33 million while sales are up an average of 23.2% since 2001. The company has $100 million in cash on its balance sheet and virtually no debt.

Forward Industries, Inc. (FORD:NASDAQ): FORD makes cell phone cases, clips and accessories for major manufacturers like Motorola and Nokia. It has a clean balance sheet with $17 million in cash and zero long-term debt. Forward’s net income and sales have increased at a 46% and 124% clip, respectively, over the last three years. And the company has been free-cash-flow positive in each of those years as well.

Internet Security Systems, Inc. (ISSX:NASDAQ): ISSX is a security company that provides software, appliances and services to global enterprises and world governments to protect their information technology (IT) infrastructure against Internet threats.

ISSX is sitting on $219.8 million in cash and no long-term debt. Sales and net income have grown at a 10% and 178% clip since 2002. The company has $186.2 million in cash from operations over the last three years. And its profit margins have improved from 0.7% in 2002 to 11.7% today.

The Knot, Inc. (KNOT:NASDAQ): KNOT provides wedding products and services to couples. The company offers both online and offline services to the wedding market. For instance, guests can shop and register for their wedding at the company’s Web site, www.theknot.com.

Business has been good for KNOT over the last several years. Sales are up an average of 18% since 2003. And its net income has followed suit — growing from $1.06 million to $3.95 million over the last two years. During that time, its profit margins have more than tripled. And the company has raked in over $11 million in cash from operations.

Currently, KNOT has $34 million in cash (to use to grow the business or reward shareholders) and $0.11 million in long-term debt.

Palomar Medical Technologies, Inc. (PMTI:NASDAQ): PMTI designs, manufactures, markets and sells lasers and accessories for use in medical and cosmetic procedures such as hair removal, cellulite and wrinkle reduction.

The medical device company’s sales and net income have grown at a CAGR rate of 44% and 658% since 2002. Profit margins have surged from minus 0.2% to 22.9%. And the company has generated $32 million in cash.

PetMed Express, Inc. (PETS:NASDAQ): PETS is the leading online pet pharmacy in the United States. It sells all the most popular items (medicine, leashes, collars, etc.) at a discount to what you would pay at the vet.

Over the last five years, business has boomed for this late-1990s online survivor. Sales and net income have grown at an incredible 43% and 95% rate over the last four years. The company has generated cash from operations in each of the last five years. It has no debt and $33 million in cash on its balance sheet. And its profit margins have grown from 2.2% in 2002 to 8.8% today.

Despite the fact that these companies are solid businesses with great numbers, investors are opting not to invest in them. Rather, they are putting their money into far more speculative companies with no real business plans. You can see that is the case if you take a look at the following chart (comparing fundamentally sound companies with companies with “garbage” fundamentals):

Eventually, this trend will change. Companies like the six mentioned in this Sleuth will make a handful of people a lot of money. Hopefully, you will be one of them.

Here’s to your wealth,
James
October 19, 2006

Penny Sleuth Contributor

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