Profit margin is a great metric to gauge the success of a business. A proper analysis of this metric reveals how well a company is run and/or what are its headwinds.

Net profit margin is the most effective way to measure a company’s profitability. It is derived by deducting all operating and non-operating expenses as well as income tax payable to the government from revenues.

Net Profit Margin = Net profit /Sales * 100.

In other words, net profit margin calculates net profit of a company for each dollar of sales.

Net Profit Margin: Pros & Cons

Net profit margin gives us a glimpse into the company’s business model in terms of pricing policy, cost structure and manufacturing efficiency. Therefore, a proper analysis of net profit margin discloses how efficiently a company is running its business and controlling costs.

However, net profit margin has a number of flaws that limit its scope as an effective analytical tool. Its calculation widely varies from industry to industry. Difference in accounting treatment of various items – especially non-cash expenses like depreciation and stock-based compensation – makes it a difficult metric for the purpose of comparison.

Further, for companies preferring to grow with debt, instead of equity funding, higher interest expense usually drags down the net profit. In such cases, it is not an effective tool to analyze the company’s performance.

The Right Strategy

In most of the times, a healthy net profit translates into solid earnings per share (EPS), which is the single most important metric that defines a well-run business. Indeed, healthy net profit margin and solid EPS growth are two of the most sought after ingredients in a business model.

Apart from these two metrics, we have added a few additional criteria to ensure maximum possible return 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 growth prospects of the stock.

Zacks Rank equal to 1: Only Strong Buy stocks are allowed. In good markets or bad, stocks with a Zacks Rank of #1 continue to outperform.

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 5 of the 10 stocks that qualified the screen:

Radio broadcasting company Entercom Communications Corp. (ETM - Snapshot Report) sports a VGM score of ‘A’ and has topped the Zacks Consensus Estimate in the last four quarters, by an average of 0.15%. The Zacks Consensus Estimate for 2016 is currently pegged at 95 cents, up a dime (11.7%) over the last 60 days.

Workers’ compensation insurance provider Amerisafe Inc. (AMSF - Analyst Report) has a VGM score of ‘B’ and has posted a positive earnings surprise of almost 25.9% on an average over the last four quarters. The Zacks Consensus Estimate for 2016 surged by 47 cents (13%) to $4.10 over the last 60 days.

Healthcare staffing company AMN Healthcare Services Inc. (AHS - Snapshot Report) has a VGM score of ‘B’ and has outperformed the Zacks Consensus Estimate by almost 24% over the last four quarters. The Zacks Consensus Estimate for 2016 soared by 20 cents (9.8%) to $2.24 over the last 60 days.

Unique Fabricating Inc. (UFAB - Snapshot Report) is a supplier of components in the automotive and industrial appliance market. The stock has a VGM score of ‘B’. Moreover, the Zacks Consensus Estimate for 2016 increased by 4 cents (4.7%) to 89 cents over the last 60 days.

Hanwha Q CELLS Co. Ltd. (HQCL - Snapshot Report) is a photovoltaic manufacturer for solar cells and modules. The stock has a VGM score of ‘B’. Further, the Zacks Consensus Estimate for 2016 surged by 34 cents (25.4%) to $1.68 over the last 60 days.