Everybody loves to invest in a business that reports profits on a regular basis. And to gauge the extent of profit there is no better metric than net profit margin.
Net Profit Margin = Net profit /Sales * 100.
Net profit margin reflects a company’s ability to convert revenues into profit after deducting all operating and non-operating expenses as well as income tax payable. In simple terms, it can also be defined as the net increase in shareholder’s equity, which the company can retain as earnings or distribute among shareholders as dividend.
Net margin helps investors assess 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, the strength in the metric not only attracts investors but also draws well-skilled employees who eventually add to the value of the business.
Moreover, a higher net profit margin as compared to peers lends a 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 crucial 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 daunting 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 for the analysis of 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 on the prospects of the stock.
Zacks Rank equal to 1: In good markets or bad, stocks with a Zacks Rank #1 (Strong Buy) 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 or 2 (Buy) offer the best upside potential.
Here are five stocks that qualified the screen:
Brazil-based Braskem SA BAK produces and sells thermoplastic resins. Together with its subsidiaries, the company is the largest petrochemical operation in Latin America. The stock has a VGM score of ‘A’. Last quarter, the company beat the Zacks Consensus Estimate by 83 cents (10.7.79%). Moreover, 2017 earnings estimates have increased by 13 cents (6.1%) to $2.26 per share over the last 30 days.
Notably, Braskem’s one-year return of 60.44% fares better than the Zacks Oil & Gas Integrated International industry’s return of 24.78%.
East Rutherford, NJ-based Cambrex Corporation CBM provides products and services that accelerate and improve the development and commercialization of new and generic therapeutics. The company has beaten earnings estimates thrice in the trailing four quarters, with the average positive surprise being 19.78%. The stock has a VGM score of ‘A’. Moreover, the Zacks Consensus Estimate for 2017 earnings has remained steady at $3.06 per share over the last 30 days.
Moreover, Cambrex’s one-year return of 26.68% is way better than the Zacks Medical-Biomedical and Genetics industry’s negative return of 22.06%.
Daqo New Energy DQ is engaged in the manufacture and sale of high-quality polysilicon to photovoltaic product manufacturers. The company has its headquarters at Wanjhou, China. Daqo has outperformed the Zacks Consensus Estimate in all of the trailing four quarters, with an average positive surprise of 112.94%. The stock has a VGM score of ‘A’. Meanwhile, the Zacks Consensus Estimate for 2017 earnings remained steady at $4.64 per share over the last 30 days.
Daqo’s one-year return of 26.26% is way better than the Zacks Chemical Specialty industry’s return of 6.51%.
Bedford, TX-based State National Companies Inc. SNC is a leading specialty provider of property and casualty insurance in the U.S. The company has managed to beat earnings twice in the trailing four quarters, with an average positive surprise of 21.28%. The stock has a VGM score of ‘B’. Moreover, the Zacks Consensus Estimate for 2017 earnings has remained steady at $1.15 per share over the last 30 days.
State National’s one-year return of 46.65% is better than the Zacks Insurance-Property and Casualty industry’s return of 22.79%.
Hounslow United Kingdom-based International Consolidated Airlines Group S.A. ICAGY is a holding company for British Airways and Iberia. The stock has a VGM score of ‘A’. Meanwhile, the Zacks Consensus Estimate for 2017 earnings has been steady at $1.58 per share 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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