Investors eye businesses that report profits on a regular basis. In order to gauge the extent of profit, there is no better metric than net profit margin.
A higher net margin reflects a company’s efficiency in converting sales into actual profit. Moreover, this metric lends an insight into how well a company is run and the headwinds confronting it.
Net Profit Margin = Net profit/Sales * 100.
In simple terms, net profit is the amount a company retains after deducting all costs, interest, depreciation, taxes and other expenses. In fact, net profit margin can turn out to be a potent point of reference to gauge the strength in a company operations and cost-control measures.
Also, higher net profit is essential for rewarding stakeholders. Net margin helps investors judge the risk involved in an investment. Creditors also view it as crucial to determining a company’s ability to pay off debts.
Moreover, a higher net profit margin compared to its peers lends the company a competitive edge.
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 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 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 on the stock.
Zacks Rank less than or equal to 2: Stocks with 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 six of the 36 stocks that qualified the screen:
Turtle Beach Corp. (NASDAQ:HEAR) is a premium San Diego, CA-based audio technology company that designs audio products for consumer, commercial and healthcare markets. The stock currently sports a Zacks Rank #1 and has a VGM Score of A. Moreover, the Zacks Consensus Estimate for 2018 earnings increased 30 cents to 97 cents per share in the last 30 days.
Headquartered in London, Ashtead Group Plc (OTCMKTS:ASHTY) is an equipment company, which provides rental solutions primarily in the United States and United Kingdom. The stock sports a Zacks Rank #1 and has a VGM Score of A. The Zacks Consensus Estimate for fiscal 2018 earnings remained stable at $7.25 per share in the last 30 days.
QuinStreet, Inc. (NASDAQ:QNST), based in Foster City, CA, is a provider of online direct marketing and media services. The Zacks Consensus Estimate for fiscal 2018 earnings increased by a penny to 45 cents over the last 30 days. The stock sports a Zacks Rank #1 and has a VGM Score of B.
Manchester-based Luxfer Holdings PLC (NYSE:LXFR) designs, manufactures, and supplies high-performance materials, components, and high-pressure gas-containment devices for healthcare, environmental, protection, and specialty end-markets in Europe, North America, and internationally. The Zacks Consensus Estimate for 2018 earnings grew 10.3% to $1.29 per share in the last 30 days. The stock sports a Zacks Rank #1 and has a VGM Score of A.
Chicago-based Enova International Inc. (NYSE:ENVA) is a provider of online financial services. The stock sports a Zacks Rank #1 and has a VGM Score of A. Further, the Zacks Consensus Estimate for 2018 earnings remained stable at $2.27 over the last 30 days.
Plano, TX-headquartered Diodes Incorporated (NASDAQ:DIOD) is a designer, manufacturer and supplier of application-specific standard products in the semiconductor market. The Zacks Consensus Estimate for 2018 earnings grew 2.6% to $2 per share in the last 30 days. The stock has a Zacks Rank #2 and a VGM Score of A.
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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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