Net profit margin is one of the profitability ratios. It measures a company’s ability to generate income relative to revenue, balance sheet assets and operating costs. A higher net profit margin shows more efficiency of the company at converting its revenue into actual profit.
This ratio is a useful way of making comparisons between companies in the same industry, for such companies are often subject to similar business conditions. Therefore, value investors can use this financial ratio to assess how well the business is performing against its peers of the same industry.
Net profit refers to the amount after deducting expenses, taxes, interest and stock dividends from the total revenue. The net profit margin shows the percentage of the revenue the company generates after deducting for these expenses.
The formula for computing the Net Profit Margin is Net Profit / Net Sales.
Say for an example, a company has a net sale of $10,000 and a net profit of $2,000. Thus, net profit margin is calculated as $2,000 / $10,000 = 0.2 or 20%.
When you look for profitable businesses, target those companies that enjoy net profit margins of 15% and above consistently over past 5 years.
Two other profit margin ratios are: