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Small cap stocks are often growing fast, but it’s always important to step back and analyze the source of that growth. More specifically, when profitability improves for a growth company, is it coming from financial leverage or improved operations?

With this question in mind, we wanted to screen small cap stocks (with market caps just over $100M) for the health of their profitability by running a DuPont analysis of their return on equity. From this analysis, we found 7 small cap companies that passed all requirements for positive results.



We broke the ROE equation into three parts:

ROE
= (Net Profit/Equity)
= (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)
= (Net Profit margin)*(Asset turnover)*(Leverage ratio)

All of the stocks mentioned below have seen rising ROE values for the recent quarter, year-over-year. Then we wanted to analyze the sources of these returns, so we narrowed down the original universe to only focus on companies with the following characteristics:

  • Decreasing leverage, i.e. decreasing Asset/Equity ratio
  • Improving asset use efficiency (i.e. declining Sales/Assets ratio) and improving net profit margin (i.e. declining Net Income/Sales ratio)

Companies passing all requirements are thus experiencing increasing profits due to operations and not to increased use of leverage.

Given the recent health of profitability for these small caps, do you think they have the projects to continue growing? Use this list as a starting-off point for your own analysis into small cap opportunities.

List sorted by increase in net profit margin.

Rocky Brands, Inc. (NASDAQ:RCKY): Apparel Footwear & Accessories Industry. Market cap of $115.26M. Return on Equity increased from 1.10% to 2.90%. When analyzing the sources of return, Net Profit Margin increased from 1.48% to 4.56%. Sales/Assets increased from 0.377 to 0.396, while Assets/Equity decreased from 1.981 to 1.606. The stock has gained 49.42% over the last year.




Eastern Co. (NASDAQ:EML): Small Tools & Accessories Industry. Market cap of $120.24M. Return on Equity increased from 0.56% to 2.33%. When analyzing the sources of return, Net Profit Margin increased from 1.32% to 4.99%. Sales/Assets increased from 0.278 to 0.319, while Assets/Equity decreased from 1.515 to 1.461. The stock has gained 39.43% over the last year.



Delta Natural Gas Co. Inc. (NASDAQ:DGAS): Gas Utilities Industry. Market cap of $106.88M. Return on Equity increased from 3.27% to 4.38%. When analyzing the sources of return, Net Profit Margin increased from 9.05% to 11.32%. Sales/Assets increased from 0.121 to 0.133, while Assets/Equity decreased from 2.994 to 2.904. The stock has gained 13% over the last year.



Nobel Learning Communities Inc. (NASDAQ:NLCI): Education & Training Services Industry. Market cap of $105.36M. Return on Equity increased from 1.48% to 2.57%. When analyzing the sources of return, Net Profit Margin increased from 1.74% to 3.06%. Sales/Assets increased from 0.426 to 0.456, while Assets/Equity decreased from 1.989 to 1.846. The stock has gained 31.66% over the last year.

Cumberland Pharmaceuticals, Inc. (NASDAQ:CPIX): Drug Manufacturer. Market cap of $104.60M. Return on Equity increased from 0.40% to 1.08%. When analyzing the sources of return, Net Profit Margin increased from 2.71% to 6.56%. Sales/Assets increased from 0.103 to 0.139, while Assets/Equity decreased from 1.436 to 1.183. The stock is a short squeeze candidate, with a short float at 12.32% (equivalent to 23.1 days of average volume). The stock has lost 52.19% over the last year.

NovaMed Inc. (NASDAQ:NOVA): Management Services Industry. Market cap of $105.18M. Return on Equity increased from 1.98% to 2.09%. When analyzing the sources of return, Net Profit Margin increased from 4.58% to 5.36%. Sales/Assets increased from 0.158 to 0.159, while Assets/Equity decreased from 2.724 to 2.452. The stock has gained 25.64% over the last year.

Asta Funding Inc. (NASDAQ:ASFI): Business Services Industry. Market cap of $119.09M. Return on Equity increased from 1.55% to 1.61%. When analyzing the sources of return, Net Profit Margin increased from 22.44% to 24.63%. Sales/Assets increased from 0.040 to 0.044, while Assets/Equity decreased from 1.708 to 1.496. The stock has gained 10.3% over the last year.

*DuPont data sourced from Google Finance (Note: All DuPont data compares the most recent quarter results to the same quarter one year ago.), all other data sourced from Finviz.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Small Cap Ideas: 7 Small Cap Stocks With Healthy Profit Trends