There is always more to a company’s story than their bottom line. Although the bottom line, or net income, is the headline number that analysts watch and journalists report, companies can earn these profits in different ways – some more preferred than others. This is why it is always a good idea to study the source of profits for a company.
One way to analyze sources of profitability is with DuPont analysis of return on equity profitability.
ROE can be broken up into three components, such that increases in ROE can be attributed to those components.
= (Net Profit/Equity)
= (Net profit/Sales)*(Sales/Assets)*(Assets/Equity)
= (Net Profit margin)*(Asset turnover)*(Leverage ratio)
Analyzing the sources of returns for a company, we can focus on companies with the following characteristics: Increasing ROE along with:
- Decreasing leverage, i.e. decreasing Asset/Equity ratio
- Improving asset use efficiency (i.e. increasing Sales/Assets ratio) and improving net profit margin (i.e. increasing Net Income/Sales ratio)
Companies passing all requirements are thus experiencing increasing profits due to operations, and not to increased use of leverage.
To illustrate this analysis, we ran DuPont on stocks with small market caps just above $100 million.
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned below. Analyst ratings sourced from Zacks Investment Research.
We also created a price-weighted index of the stocks mentioned below, and monitored the performance of the list relative to the S&P 500 index over the last month. (To access a complete analysis of this list's recent performance, click here.)
Do you think these companies have impressive profitability? Use this list as a starting-off point for your own analysis.
List sorted by market cap.
1. OmegaFlex, Inc. (NASDAQ:OFLX): Engages in the manufacture and sale of flexible metal hoses principally in North America and Europe. Market cap of $132.18M. MRQ Net Profit Margin increased to 8.74% from 6.16% year-over-year, Sales/Assets increased to 0.49 from 0.37, while Assets/Equity decreased to 1.36 from 1.88. The stock has lost 2.46% over the last year.
2. Independence Holding Co. (NYSE:IHC): Engages in the life and health insurance business in the United States, the District of Columbia, the Virgin Islands, Guam, and Puerto Rico. Market cap of $131.07M. MRQ Net Profit Margin increased to 2.88% from 1.60% year-over-year, Sales/Assets increased to 0.0777 from 0.0766, while Assets/Equity decreased to 5.50 from 6.09. The stock is a short-squeeze candidate, with a short float at 5.15% (equivalent to 10.54 days of average volume). The stock has performed poorly over the last month, losing 12.2%.
3. TESSCO Technologies Inc. (NASDAQ:TESS): Provides integrated product and supply chain solutions to support the construction, operation, and use of mobility and data wireless systems. Market cap of $112.92M. MRQ Net Profit Margin increased to 2.79% from 1.46% year-over-year, Sales/Assets increased to 0.91 from 0.85, while Assets/Equity decreased to 2.16 from 2.34. The stock has had a couple of great days, gaining 5.2% over the last week.
4. Carriage Services Inc. (NYSE:CSV): Provides death care services and merchandise in the United States. Market cap of $105.86M. MRQ Net Profit Margin increased to 5.43% from 5.17% year-over-year, Sales/Assets increased to 0.0707 from 0.0698, while Assets/Equity decreased to 5.37 from 5.56. The stock has had a couple of great days, gaining 6.48% over the last week.
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.