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Net profit margin is the most effective way to measure a company’s profitability. A proper analysis of the same reveals how well a company is run and the headwinds confronting it.

A higher net margin reflects the company’s efficiency at converting sales into actual profit.

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 indispensable for rewarding stakeholders. Further, strength in the metric not only attracts new investors but also draws well-skilled employees that eventually add to the value of the business.

Moreover, a higher net profit margin as compared to peers lends a company 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 vital 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 complex 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 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.

Screening Parameters

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 prospects of the stock.

Zacks Rank equal to 1: Only Zacks Rank #1 (Strong Buy) stocks are allowed. In good markets or bad, Strong Buy stocks continue to outperform. 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 offer the best upside potential.

Here are five of the nine stocks that qualified the screen:

Wood Dale, IL-based AAR Corp. (AIR - Free Report) provides various products and services to the aviation and defense industries worldwide. Its principal customers include The Boeing Company and Airbus. The stock has a VGM score of ‘B’. Moreover, the Zacks Consensus Estimate for fiscal 2017 has increased by 9 cents (5%) to $1.48 over the last 30 days.

Rockville, MD-based Argan Inc. (AGX - Free Report) provides inside premise wiring services to the federal government. The company also offers underground and aerial construction services and splicing to major telecommunications and utilities customers. The stock has a VGM score of ‘A’. Moreover, the Zacks Consensus Estimate for 2016 has increased by 45 cents (14%) to $3.65 over the past 30 days.

Denver, CO-based Hallador Energy Company (HNRG - Free Report) is engaged in the production and sale of steam coal used for power generation. The company has a VGM Score of ‘B’. Its earnings estimate for the current year has remained steady at 59 cents over the last 30 days.

CO-based Innospec Inc. (IOSP - Free Report) develops, manufactures, blends, markets and supplies fuel additives, oilfield chemicals, personal care and other specialty chemicals. The stock has a VGM score of ‘B’. The Zacks Consensus Estimate for 2016 has remained steady at $3.80 over the past 30 days.

U.S. Auto Parts Network Inc. (PRTS - Free Report) is a leading online provider of automotive aftermarket parts, including body parts, engine parts, performance parts and accessories. The company has its headquarters at Carson, CA. The stock has a VGM score of ‘A’. Meanwhile, the Zacks Consensus Estimate for 2016 has increased by a couple of cents to 7 cents 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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