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Investors flock to a business that reports profits on a regular basis. And to gauge the extent of profit there is no better metric than the net profit margin.

Net Profit Margin = Net profit /Sales * 100.

Net profit margin reflects a company’s ability to convert revenues into profits after deducting all operating and non-operating expenses as well as income tax payable.

Hence, a healthy net profit margin shows how successfully management has controlled costs. We note that stringent cost control as well as a lean cost structure provides a cushion to the company’s profitability during periods of downturn.

Also, higher net profit is indispensable for rewarding stakeholders. Further, the 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 the five stocks that qualified the screen:

Athens, Greece-based Aegean Marine Petroleum Network Inc. (ANW - Snapshot Report) is a marine fuel logistics company that physically supplies and markets refined marine fuel and lubricants to ships in port and at sea. The stock has a VGM score of ‘A’. Moreover, the Zacks Consensus Estimate for fiscal 2017 has remained steady at $1.24 over the last 30 days.

Rockville, MD-based Argan Inc. (AGX - Snapshot 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 remained stable at $3.65 over the past 30 days.

Denver, CO-based Hallador Energy Company (HNRG - Snapshot Report) is engaged in the production and sale of steam coal used for power generation. The company has a VGM Score of ‘A’. Its earnings estimate for the current year has increased by a penny to 60 cents over the last 30 days.

Tokyo -based Nippon Telegraph and Telephone Corporation (NTT - Snapshot Report) provides a variety of telecommunications services, including telephone, telegraph, leased circuits, data communication, terminal equipment sales and other services in Japan. The stock has a VGM score of ‘A’. The Zacks Consensus Estimate for fiscal 2017 has remained unchanged at $3.81 over the past 30 days.

Munich, Germany-based Bayerische Motoren Werke AG (BAMXF - Snapshot Report) is a multi-brand automobile manufacturer that focuses on the premium segments of the worldwide automobile and motorcycle markets. The stock has a VGM score of ‘B’. Meanwhile, the Zacks Consensus Estimate for 2016 has increased by 42 cents (4.1%) to $10.73 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.

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