A profitable company is able to provide satisfactory returns to its investors even after meeting all its operating and non-operating costs. The best way to assess a company’ potential is to use profitability analysis. Although a company with strong profitability but weak fundamentals may fail to perform effectively, studies have shown that a profitable entity will generally ensure attractive returns for its investors.
Here we have used the concept of accounting ratios to evaluate a company’s profitability. There are a variety of profitability ratios, from which we have chosen the most common and successful profitability metric, to determine the bottom-line performance of a company.
Net Income Ratio
Profitability ratios in general are classified into gross income ratio, operating income ratio, pretax profit margin and net income ratio. We have selected net income ratio in order to assess the exact level of profitability of a company.
Net income ratio is measured by dividing net income by total sales revenue. The higher the net income ratio, the better will be the company’s profitability. This is because it showcases how effectively the company shells out all its business-related expenses and generates funds.
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: Only Zacks Rank #1 (Strong Buy) stocks are allowed. With the Zacks Rank proving to be one of the best rating systems out there, 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 Net Income Ratio Higher than X Industry: A higher net income ratio indicates a company’s solid profitability.
12-Month Trailing Sales and Net Income Growth Higher than X Industry: Stocks that have displayed higher sales and net income growth in the last 12 months give a better financial performance.
% Rating Strong Buy greater than 70%: This indicates that 70% of the analysts covering these stocks are optimistic.
Here are five of the 10 stocks that qualified the screening:
II-VI Incorporated IIVI designs, manufactures and markets optical and opto-electronic components, devices and materials for infrared, near-infrared, visible light, x-ray and gamma ray instrumentation. It has an average four-quarter earnings surprise of 59.2%.
FCB Financial Holdings, Inc. is a bank holding company for Florida Community Bank. It has an average four-quarter earnings surprise of 1.4%.
Open Text Corporation OTEX is engaged in the development of innovative intranet, extranet and e-Business applications. It has an average four-quarter earnings surprise of 14.7%.
Rice Midstream Partners LP RMP is a midstream energy company. It has an average four-quarter earnings surprise of 44.5%.
Allegiance Bancshares, Inc. ABTX operates as a bank holding company. It has an average four-quarter earnings surprise of 14.2%.
While backtesting over a two-year timeframe (January 16, 2015 to January 13, 2017), a portfolio following this strategy provided a total return of 31.8% compared with the S&P 500’s return of 9.1%. 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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