Net profit, also referred to as the bottom line, is one of the key tools that determines the financial health of an enterprise. The metric demonstrates a company’s ability to convert per dollar sales into profits.
A low-profit margin indicates higher risks, implying that a revenue drop might dampen profits, pushing the company in the red (net loss).
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 of a company’s operations and its cost-control measures.
Also, higher net profit is essential for rewarding stakeholders. Further, strength in the metric not only attracts investors but also draws well-skilled employees who eventually enhance business value.
Moreover, a higher net profit margin compared with its peers provides 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.
In addition, the difference in accounting treatment of various items — especially non-cash expenses like depreciation and stock-based compensation — makes comparison a daunting task.
Furthermore, 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, while analyzing 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. You can see the complete list of today’s Zacks #1 Rank stocks here.
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 15 stocks that qualified the screen:
Flexible Solutions International Inc. (FSI - Free Report) is an environmental company focusing on the research, development and manufacturing of products that save water and energy. At present, this Zacks #2 Ranked player has a VGM Score of A. The Zacks Consensus Estimate of 33 cents for current-year earnings has moved up 8 cents over the past 30 days.
Gibraltar Industries Inc. (ROCK - Free Report) manufactures and distributes building products for the industrial, infrastructure, residential, renewable energy, and conversation markets. The products range from ventilation and expanded metal to mail storage solutions and rain dispersion products and solutions. The stock currently carries a Zacks Rank of 2 and has a VGM Score of A. The Zacks Consensus Estimate for 2020 earnings has been revised upward to $2.97 from $2.38 in 30 days’ time.
Herc Holdings, Inc. (HRI - Free Report) is an equipment rental supplier across North America and in international markets. This Zacks Rank #2 stock has a VGM Score of A. The Zacks Consensus Estimate of $1.80 for current-year earnings has been revised upward by $1.39 over the past 60 days.
360 Finance Inc. (QFIN - Free Report) offers digital consumer finance platform. The company provides online consumer finance products to prime, underserved borrowers funded primarily by its funding partners. The stock currently carries a Zacks Rank of 2 and has a VGM Score of A. The Zacks Consensus Estimate for 2020 earnings has been revised upward to $2.79 from $2.32 in seven days’ time.
CBIZ, Inc. (CBZ - Free Report) provides professional business services that help clients better manage their finances and employees. The company offers financial, insurance, and advisory services across the United States and Canada. The stock currently carries a Zacks Rank of 2 and has a VGM Score of A. The Zacks Consensus Estimate of $1.31 for current-year earnings has been revised upward from $1.11 in the past 60 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/.