The primary purpose of a business is to generate profits that can be reinvested for expansion or utilized to reward shareholders. Net profit margin is an effective tool for the measurement of profit generated by a business.
Net Profit Margin = Net profit/Sales * 100
Net profit of a business is the amount that remains in the last line (also known as bottom line) of the income statement after all costs (including taxes) have been deducted from revenues.
In fact, net profit margin can turn out to be a potent point of reference to gauge the strength in a company’s operations and cost-control measures.
Higher net profit is essential for rewarding stakeholders. Net margin helps investors judge the risks of investing in a company. Creditors also view it as a major factor in determining a company’s ability to pay off debts.
Moreover, a higher net profit margin as compared to peers lends a competitive edge. Strength in the metric not only attracts investors but also draws well-skilled employees that eventually add to the value of the business.
Pros and Cons
Net profit margin helps investors gain clarity on a company’s business model in terms of pricing policy, cost structure and manufacturing efficiency. Hence, a strong net profit margin is preferred by all classes of investors.
However, net profit margin as an investment criterion has its own share of pitfalls. The metric varies widely from industry to industry. While net income is a key metric for investment measurement in traditional industries, it is not that important for technology companies.
Moreover, the difference in accounting treatment of various items — especially non-cash expenses like depreciation and stock-based compensation — makes comparison a daunting task.
Further, for companies preferring to grow with debt, instead of equity funding, higher interest expenses usually weigh on the net profit. In such cases, the measure is rendered ineffective to analyze a company’s performance.
The Winning Strategy
A healthy net profit margin and solid EPS growth are the two most sought-after elements in a business model.
Apart from these, we have added a few other criteria to ensure maximum returns from this strategy.
Net Margin 12 months – Most Recent (%) greater than equal to 0: High net profit margin indicates solid profitability.
Percentage Change in EPS F(0)/(F-1) greater than equal to 0: It indicates earnings growth.
Average Broker Rating (1-5) equal to 1: A rating of #1 indicates brokers’ extreme bullishness of the stock.
Zacks Rank less than or equal to 2: Stocks having a Zacks Rank #1 (Strong Buy) or 2 (Buy) generally perform better than their peers in all types of market environment.
VGM Score of A or B: Our research shows that stocks with a VGM Score of A or B when combined with a Zacks Rank #1 or 2 offer the best upside potential.
Here are five of the 14 stocks that qualified the screen:
New Albany, OH-based Commercial Vehicle Group, Inc. (NASDAQ:CVGI) supplies interior systems, vision safety solutions and other cab-related products to the global commercial vehicle market. The stock has a Zacks Rank #1 and a VGM Score of B. The Zacks Consensus Estimate for fiscal 2017 earnings remained steady at 36 cents over the last 30 days.
France-based Arkema S.A. (OTCMKTS:ARKAY) is engaged in the manufacturing and marketing of vinyl, industrial chemicals, and performance products. The stock has a Zacks Rank #2 and a VGM Score of A. Moreover, the Zacks Consensus Estimate for 2017 earnings has increased a couple of cents to $8.53 over the last 30 days.
Headquartered in Fort Washington, PA, Nutrisystem Inc. (NASDAQ:NTRI) provides weight management products and services for women and men. The stock carries a Zacks Rank #2 and a VGM Score of B. Notably, the Zacks Consensus Estimate for 2017 earnings has climbed by 4 cents to $1.94 over the last 30 days.
Gibraltar Industries Inc (NASDAQ:ROCK) manufactures and distributes products to the industrial and buildings market. The company has its headquarters at Buffalo, NY. The stock has a Zacks Rank #2 and a VGM Score of A. Meanwhile, the Zacks Consensus Estimate for 2017 earnings has increased by 3 cents to $1.58 per share over the last 30 days.
Willdan Group, Inc. (NASDAQ:WLDN) is a provider of professional technical and consulting services to utilities, private industry, and public agencies at all levels of the government. The stock has a Zacks Rank #2 and a VGM Score of A. The Zacks Consensus Estimate for fiscal 2017 earnings rose by 6 cents to $1.16 over the last 30 days.
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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.
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