Profitability analysis is generally used to evaluate the potential of a company’s stock. A company with high profitability has surplus sales to meet all its operating and non-operating expenses and generate attractive returns for investors.
A profitable company with weak fundamentals may fail to give a satisfying stock performance. However, several studies have indicated that a company with high profitability normally offers positive returns to its investors.
Here, we have used the concept of profitability ratios to determine how prosperous a company actually is. There are several profitability ratios, from which we have selected net income ratio. Net income ratio is the simplest and most useful profitability metric.
Net Income Ratio
Net income ratio reveals the bottom line of a company. It reflects the percentage of net income to total sales. Using net income ratio, one can measure a company’s effectiveness to clear all its operating and non-operating expenses from sales revenue alone. A higher net income ratio normally implies a company’s ability to generate ample revenue and successfully manage all its business functions.
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: The Zacks Rank has proved itself to be one of the best rating systems out there. Since this screening allows only Zacks Rank #1 (Strong Buy) stocks, 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 Sales and Net Income Growth Higher than X Industry: Stocks that possess higher sales and net income growth in the last 12 months showcase better financial performance.
12-Month Trailing Net Income Ratio Higher than X Industry: High net income ratio indicates a company’s solid profitability.
% 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:
Entegris, Inc. ENTG is a leading provider of materials management solutions to the microelectronics industry, including semiconductor manufacturing and disk manufacturing markets. It has an average four-quarter earnings surprise of 20.7%.
SORL Auto Parts, Inc. SORL specializes in the development, production and distribution of different auto parts, including automotive brake systems. It has an average four-quarter earnings surprise of 7.5%.
Rice Midstream Partners LP RMP is an energy and oil company. It has an average four-quarter earnings surprise of 37.1%.
Interval Leisure Group, Inc. IILG is a leading provider of leisure services to consumers and business-to-business customers in the vacation industry. It has an average four-quarter earnings surprise of 8.4%.
HollySys Automation Technologies, Ltd. HOLI is one of the leading automation systems’ providers in the People's Republic of China. The company has an average four-quarter earnings surprise of 6.1%.
While backtesting over a two-year timeframe (September 5, 2014 to September 9, 2016), a portfolio following this strategy provided a total return of 11.2% compared with the S&P 500’s return of 7.1%. 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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