The primary purpose of a business is to generate profits that can be reinvested in expansion or utilized to reward shareholders. Net profit margin is an effective tool for the measurement of profit generated by a business.
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.
Higher net profit is indispensable for rewarding stakeholders. Net margin helps investors judge the risks of investing in a company. Creditors also view it as a major factor in determining a company’s ability to pay off debts.
Moreover, a higher net profit margin as compared to peers lends a competitive edge. Also, strength in the metric not only attracts new investors but also draws well-skilled employees that eventually add to the value of the business.
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.
Moreover, the difference in accounting treatment of various items – especially non-cash expenses like depreciation and stock-based compensation – makes comparison an uphill task.
Further, for companies preferring to grow with debt, instead of equity funding, higher interest expenses usually weigh on the 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 the 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.
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 of the stock.
Zacks Rank less than or equal to 2: Stocks having 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 (Buy) offer the best upside potential.
Here are five of the 21 stocks that qualified the screen:
Tokyo, Japan-based Hitachi Ltd. (HTHIY - Free Report) is one of the world's leading global electronics companies. The company manufactures and markets a wide range of products, including computers, semiconductors, consumer products and power and industrial equipment. The stock sports a Zacks Rank #1 and has a VGM score of ‘A’. Meanwhile, the Zacks Consensus Estimate for 2017 earnings has remained steady at $5.48 per share for the last 30 days.
El Segundo, CA-based PCM Inc. (PCMI - Free Report) is a technology solutions provider to businesses, government and educational institutions as well as individual consumers. The stock sports a Zacks Rank #1 and has a VGM score of ‘A’. Notably, the Zacks Consensus Estimate for 2017 earnings has remained unchanged at $1.96 in the last 30 days.
Netherlands-based Koninklijke DSM NV (RDSMY - Free Report) is involved in the chemicals industry. The company’s main focus is on base materials, performance materials, materials processing, base chemicals and fine chemicals and coating resins. The stock sports a Zacks Rank #1 and has a VGM score of ‘B’. Moreover, the Zacks Consensus Estimate for 2017 has increased three cents to $1.05 in the last 30 days.
Luxembourg-based Aperam (APEMY - Free Report) is a renowned manufacturer and retailer of stainless, and specialty steel products. The stock sports a Zacks Rank #2 and has a VGM score of ‘A’. Moreover, 2017 earnings estimate has remained steady at $4.25 per share for the last 30 days.
Santiago, Chile-based Embotelladora Andina S.A. (AKO.B - Free Report) produces and distributes Coca-Cola products in Chile, Brazil and Argentina. The company sports a Zacks Rank #2 and has a VGM Score of ‘B’. The Zacks Consensus Estimate for 2017 earnings has remained steady at $1.16 for 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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