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Healthcare and medical technology is a risky sector. The costs of development often far outweigh the returns, at least in the short run. New technology and treatments are perfected and approved regularly, making many investors millionaires overnight. The market is flooded with small healthcare businesses, many of which probably won't be here in a year or two. Profitability is the key to success when investing in small cap health stocks. A proven revenue stream makes the stock more of an investment and less of a speculation. Looking carefully into each companies product, market and financial report is the surest way to success. Here is a look at five small cap healthcare stocks, three to keep an eye on and two to avoid.

QLT PhotoTherapuetics Inc (QLTI) is an innovator in light activated drugs and therapies in the treatment of diseases. Their revolutionary technology has advanced the field to the point of break through in ophthalmology and auto-immune disorders. The stock has been trending sideways for over a year, while the company built support among investors. More than 60% of the stock is held by institutions but inside ownership is negligible. The Short ratio is on the high side right now, a little over 7%, but I think the bears are in decline. The company has been increasing sales of its flagship product line, Visudyne. The costs of sales have also increased. Much of the cost increase is due to marketing costs for Visudyne and increased spending on research and development. The stock is currently trading around $7.50, near the top of its 12 month range. The company has reaffirmed sales guidance toward the top end of its previous range. The next release is scheduled for late February 2012. A positive announcement could lead to a short squeeze. However, the market for Visudyne is very limited. U.S. sales have been dropping off and increased costs of marketing are biting into revenue. QLT is in a trading range and will stay there until margins improve.

Merge Healthcare (MRGE) develops medical imaging and clinical software applications for radiology in hospitals and clinics. The company's software is gaining widespread acceptance throughout the medical field and is being added to radiology programs around the world. Revenue in the third quarter of 2011 grew by over 30% and analysts expect more in 2012. Net sales and operating income grew by double digits and the operating loss in the quarter shrank to $.01 per share. Ongoing software sales and licensing will boost results in 2012. Only 25% of the float is owned by private investors and the short ratio is high. The stock has reclaimed some of the recent losses in share value but a mixture of profit taking, cutting of losses and bearish speculation could bring the price back to its support around $4.5. If this happens then it will be a good time to get into this one. This company will be posting revenue growth and profits which will take share price up over $7 from the current level just shy of $6.

ExamWorks Group (EXAM) provides second opinions for the medical community through independent examinations, peer reviews and other related services. The business is expanding rapidly, several acquisitions were made in 2011 that increased the groups presence in the field. Revenue in the third quarter of 2011 rose by over 125% from the same period last year. The company's costs rose dramatically as well but the statement explained that revenue from the newly acquired businesses had not yet impacted the bottom line. The board is expecting revenue to grow in 2012 by more than 30%, based in part on purchased revenue related to 2011 acquisitions and on organic growth of business. The stock is currently trading around 40% lower than its IPO price of $16.75. Share price appears to have bottomed and I expect to see it gain when profits beat estimates in 2012. As is this stock is going to trade down until investors can trust profitability.

Ziopharm Oncology (ZIOP) is a developer of cancer treatments. They build on existing treatments to fill unmet needs in the oncology field. The company is a research stage pharmaceutical with no income. This is purely a long term play on whether or not pharmacy can produce results. The company is engaged in several clinical trials and partnerships in the development of treatment. There is no word on when the company expects to begin bringing in any revenue. The stock is currently trading around $5.25 and is above the 200 day moving average. The stock has some support but I think its too risky. There are other healthcare stocks to choose from

BioScrip (BIOS) provides comprehensive pharmacy solutions to hospitals, clinics and individuals. It operates in metropolitan areas, through the mail and in the home. The company is engaged primarily with the treatment of transplant, oncology and other patients with high pharmacy needs. Net revenue grew slowly from the previous year at a little over 2%. Earnings per share in the third quarter were $.10, up from last year loss. The company is expected to increase earnings next year by around 400%. BioScrip is streamlining its operations and reducing costs which helped to increase cash flow. 2011 earning were negatively impacted by restructuring expenses including acquisitions and severance pay. The stock is currently trading around $6.50 and appears to be building a base between $4 and $5.

Source: 5 Small Cap Health Services Stocks To Watch