I’ve written before about the process of de-risking microcap stocks, and I’m still of the philosophy that taking fast, strong, reliable gains is better than holding out for those life-changing, five-figure monsters that we hear about but somehow never get to exploit.

That said, just as there is a way to slice more than 99% of the risk from a microcap investment based on some very basic and very fundamental principles of volatility, there is also a way to isolate the variables that make the possibility of landing a five-figure gainer far more likely.

De-risking is a common term in investor lingo. But this is different. Now we’re talking about re-risking.

It seems counterintuitive, but to seasoned investors, the frustration of untapped potential is sometimes enough to warrant the most speculative swing possible.

And for those who are properly hedged against loss, big swings are sometimes the most important of all.

Take Reid Hoffman, for example — a famous, now-legendary venture capitalist.

Already a multi-millionaire, he decided to risk a mere $40,000 on a social networking start-up about 10 years ago.

When Facebook had its IPO in 2012, Reid’s investment was worth just shy of half a billion.

It wasn’t the biggest risk of his career, but you better believe it was the biggest home run.

Before I continue, I want to reiterate — just as I did when I wrote about de-risking — that there is no such thing as a system for finding a winning stock.

The only methodology with any scientific validity whatsoever is based on excluding bad candidates in order to increase the chance of success with the remaining pool.

Sounds pretty simple if you ask me: the systematic exclusion of candidates unlikely to achieve the desired results.

So here’s how I adapted the method…

De-risking your microcap stocks involved filtering based on:

• Cash/share ratio
• Profit margin
• Gross margin
• No dividend

To re-risk your microcap stocks so as to maximize profit potential, you need to flip this equation on its head a little bit.

Here’s How We Do It…

Profit means favorable earnings reports. Favorable earnings reports mean appreciating share prices…

So if you want to buy something at the very start of its life cycle — in other words, with the highest degree of remaining potential — you need to exclude profitability.

It’s painful, but it needs to be done.

Applying your filters, you should specify a maximum zero-profit margin… In fact, if you’re looking for the early development-stage companies, you want no earnings at all.

You want to stick to the no-dividend rule… and you want to stick to the positive cash rule, because taking risks on insolvent companies — regardless of the state of their research and development — is never a good idea.

So let’s run the algorithm and see what we get:

First step, keep the market capitalization between $4 million and $50 million. No need to go bigger. Bigger companies no longer qualify as development-stage.

Next step, set maximum dividends at 0.

Next step, set maximum gross margins at 0.

Next step, set maximum profit margins at 0.

Then we look at average volume. You want this company to trade, but not too much. Too much trading indicates that it’s too well known among speculators. Too little means too much risk — even for this bracket of microcap companies.

Set the minimum at 10,000 shares a day to cover the pricier stocks and the maximum at 150,000 to cover those true penny stocks.

Finally, set your cash at positive, with the minimum cash-to-share ratio at 0.2.

The Result

You’ve just whittled a field of more than 5,000 companies — with a total market capitalization of between $4 million and $50 million — down to 35 companies.

35 companies that show all the signs of future prospective but have shaken all those symptoms of decline.

Now, does that mean these 35 are going to deliver those orbit-changing gains?

Definitely not.

Taking that field of 35 down to three or so will take most of the effort and most of the thinking.

You’ll need to look at what they do and, most importantly, the future of what they do — because companies in this segment cannot be anything but forward thinking.

Properly apply those parameters, and you’ll get a handful of stocks with the absolute highest profit potential — by process of elimination.

Of course, your personal methodology for those final 30 or so companies is what’s really going to matter, and yes, I do have my own.

But methods aside, just remember one thing:

Fortune favors the bold.

– John Peterson