4 small stocks offering big returns

A focus on firms with high returns on equity can help an investor identify high quality stocks.

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

An important metric for investors to understand and utilise when analysing stocks is the concept of return on equity (ROE). Essentially, ROE measures the return (measured by profit) that a company is generating by utilising the money that shareholders have invested.

Intuitively it makes sense to compare the return being generated by a company on the money invested in that company, and in fact Warren Buffett is an enthusiastic proponent of the metric.

Most importantly, ROE can help identify companies that are not only creating value for shareholders but also identify companies that could possess a sustainable competitive advantage.

Here are four stocks which all possess high returns on equity. The parameters for the search criteria used to identify these four stocks included: a market capitalisation of less than $1 billion,  forecast earnings per share (EPS) growth in the “double digits” (in other words over 10%), a strong balance sheet – indeed in most cases these companies are actually net cash, and importantly a ROE of at least 20%.

1)      RCG Corporation Limited (ASX: RCG) is a specialty retailer of athletic footwear primarily through The Athlete’s Foot branded store network. Interestingly, despite a competitive retail environment, RCG has managed to maintain above average returns which suggests it possesses some form of comparative advantage. It should produce ROE of around 24% in financial year (FY) 2014.

2)      Ozforex Group Ltd (ASX: OFX) has carved out a profitable niche as the “go-to” online provider for customers needing a foreign exchange transaction. While the high level of profitability is bound to encourage competition, currently OzForex enjoys ROE of over 50%.

3)      Sirtex Medical Limited (ASX: SRX) looks set to continue its high levels of growth thanks to its innovative treatment for liver cancer. The technical nature of Sirtex’s product gives the company a strong comparative advantage which is displayed by its expected ROE of 24% in FY 2014.

4)      SFG Australia Ltd (ASX: SFW) is a full service provider of wealth management services. A 2011 merger has given SFG a substantial national footprint and a ROE of around 20%.

Foolish takeaway

It’s always handy to compare a firm’s ROE against its peer group as this allows an investor to understand what the average return for firms operating in a particular industry are. In other words – certain industries have the ability to generate higher average returns on equity than others.

Another important aspect of ROE analysis is to identify companies that also have the ability to reinvest their earnings – Sirtex and OzForex stand out in this respect. This is important as it allows for earnings to be compounded at these high rates of ROE which is generally more valuable to a shareholder than a high ROE company that does not have reinvestment opportunities and instead pays those earnings out as a dividend.

Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

asx share price competitions represented by businessmen arm wrestling
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

person reading news on mobile phone
⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »