Seeking Alpha
Value, growth, long-term horizon, medium-term horizon
Profile| Send Message|
( followers)  

One concern many investors have about smaller market cap, low-priced stocks is whether the firm’s profitability is growing. But equally concerning should be the sources of that growth, whether it is from increased borrowing or increased efficiency and operational growth.

For that reason, we ran a DuPont analysis of return on equity for about 100 of the largest cap stocks trading under $5. From this analysis, we found 3 companies that passed all requirements for positive sources of return on equity. 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.

Do you think these stocks are likely to move higher, given their healthy sources of profitability? Use this list as a starting-off point for your own analysis.

List sorted by increase in quarterly ROE year-over-year.

1. Tower Semiconductor Ltd. (NASDAQ:TSEM):
Semiconductor Industry. Market cap of $318.01M. Price at $1.28. Return on Equity increased from -56.08% to 1.10%. When analyzing the sources of return, Net Profit Margin increased from -31.22% to 0.96%. Sales/Assets increased from 0.1546 to 0.1685, while Assets/Equity decreased from 11.6201 to 6.8070 (comparing 3 mo. ending 12/31/09 vs. 3 mo. ending 12/31/10). It's been a rough couple of days for the stock, losing 5.51% over the last week.



2. Move, Inc. (NASDAQ:MOVE):
Business Services Industry. Market cap of $330.14M. Price at $2.01. Return on Equity increased from -10.14% to 0.56%. When analyzing the sources of return, Net Profit Margin increased from -38.92% to 1.49%. Sales/Assets increased from 0.1676 to 0.2955, while Assets/Equity decreased from 1.5542 to 1.2665 (comparing 3 mo. ending 3/31/10 vs. 3 mo. ending 3/31/11). The stock has gained 4.52% over the last year.



3. X-Rite, Incorporated (NASDAQ:XRIT): Photographic Equipment & Supplies Industry. Market cap of $392.75M. Price at $4.58. Return on Equity increased from 0.03% to 1.80%. When analyzing the sources of return, Net Profit Margin increased from 0.14% to 6.75%. Sales/Assets increased from 0.1054 to 0.1343, while Assets/Equity decreased from 2.2370 to 1.9820 (comparing 3 mo. ending 1/2/10 vs. 3 mo. ending 1/1/11). The stock has gained 30.95% over the last year.



*Accounting data sourced from Google Finance, 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: 3 Stocks Under $5 With Encouraging Sources of Profitability