The primary purpose of a business is to generate profits that can be reinvested in the expansion or utilization of rewarding shareholders. Net profit margin is an effective tool for the measurement of profits 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 company operations and cost-control measures.

Also, higher net profit is essential for rewarding stakeholders. Net margin helps investors judge the risk involved in an investment. Creditors also view it as crucial to determining a company’s ability to pay off debts.

Moreover, a higher net profit margin compared to its peers lends the company 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 important for technology companies.

Moreover, the difference in the 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 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 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 stock.

Zacks Rank less than or equal to 2: Stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) generally perform better than peers in all types of market environment.

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 offer the best upside potential.

Here are five of the 19 stocks that qualified the screen:

Singapore-based Broadcom Limited (AVGO - Free Report) designs, develops and supplies a range of complex digital and mixed signal complementary metal oxide semiconductor-based devices and analog III-V based products worldwide. The stock has a Zacks Rank #1 and a VGM Score of B. The Zacks Consensus Estimate for fiscal 2018 earnings has increased 9 cents to $19.33 per share in the last 30 days. You can see the complete list of today’s Zacks #1 Rank stocks here.

France-based Arkema SA (ARKAY - Free Report) is engaged in the manufacturing and marketing of vinyl, industrial chemicals, and performance products. The stock has a Zacks Rank #2 and a VGM Score of A. Moreover, the Zacks Consensus Estimate for 2017 earnings has increased by 6 cents to $8.66, in the last 30 days.

Johnson Outdoors Inc. (JOUT - Free Report) is a leading global outdoor recreation company that designs, manufactures and markets a portfolio of brands across four categories: Watercraft, Marine Electronics, Diving and Outdoor Equipment. The stock sports a Zacks Rank #1 and a VGM Score of A. The Zacks Consensus Estimate for fiscal 2018 earnings has climbed 14 cents to $3.27, over the last 30 days.

Headquartered in Racine, WI, Modine Manufacturing Company (MOD  - Free Report) is a designer, manufacturer, and distributor of thermal management systems and components for several end markets. The stock carries a Zacks Rank #2 and has a VGM Score of A. The Zacks Consensus Estimate for fiscal 2018 earnings has remained steady at $1.43, over the last 30 days.

DAQO New Energy Corp. (DQ - Free Report) is a manufacturer and seller of polysilicon and wafers. The stock carries a Zacks Rank #1 and has a VGM Score of A. Further, the Zacks Consensus Estimate for 2017 earnings remained unchanged at $7.81, over the last 30 days.