Profitability analysis is one of the best ways to evaluate the prospect of a company’s stock. It helps to figure out whether the company has surplus sales revenue even after meeting all its costs and expenses. Plus, it ensures whether the company can generate stable returns for investors. This makes a profitable company a preferred choice over a loss-making one.
However, if a profitable company has weak fundamentals, it may not be able to give a satisfying stock performance. Several studies have indicated that a company with high profitability normally offers healthy returns to its investors.
Profitability ratios are used here to measure a company’s profitability position. Although there are various profitability ratios, we have chosen net income ratio for putting together a screen. Net income ratio is the simplest and most effective profitability metric.
Net Income Ratio
Net income ratio reveals the bottom line of a company. It reflects the percentage of net income to total sales. Using net income ratio, one can measure a company’s effectiveness to clear all its operating and non-operating expenses from sales revenue alone. A higher net income ratio normally implies a company’s ability to generate ample revenue and successfully manage all its business functions.
Net income ratio is not the only indicator of future winners. As such, we have added a few additional criteria to arrive at a winning strategy.
Zacks Rank equal to #1: The Zacks Rank has proven itself as one of the best rating systems out there. Since this screening allows only Zacks Rank #1 (Strong Buy) stocks, this is a great way to start things off. You can see the complete list of today’s Zacks #1 Rank stocks here.
12-Month Trailing Sales and Net Income Growth Higher than X Industry: Stocks that witnessed higher sales and net income growth in the last 12 months showcase a better financial performance.
12-Month Trailing Net Income Ratio Higher than X Industry: High net income ratio indicates a company’s solid profitability.
% Rating Strong Buy greater than 70%:This indicates that 70% of the analysts covering these stocks are optimistic.
Here are five of the six stocks that qualified the screening:
Limoneira Company (LMNR - Snapshot Report) is an agribusiness and real estate development company. Its expected earnings growth for the current year is 149.1%.
Premier, Inc. (PINC - Snapshot Report) operates as a healthcare alliance in the U.S. The company’s expected earnings growth for the current year is 91.6%.
PRA Health Sciences, Inc. (PRAH - Snapshot Report) operates as a global contract research organization providing outsourced clinical development services to the biotechnology and pharmaceutical industries. The company’s expected earnings growth for the current year is 23.5%.
Ariad Pharmaceuticals Inc. (ARIA - Analyst Report) is engaged in the discovery and development of drugs to cure cancer not only in the U.S. but also globally. The company’s expected earnings growth for the current year is 92.9%.
HollySys Automation Technologies, Ltd. (HOLI - Snapshot Report) is one of the leading automation systems’ providers in the People's Republic of China. The company’s expected earnings growth for the current year is 11%.
While backtesting over a two-year timeframe (September 26, 2014 to September 23, 2016), a portfolio following this strategy provided a total return of 24.8% compared with the S&P 500’s return of 7.5%. Thus, this strategy may prove profitable for those looking to beat the markets.
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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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