Investing In High Profit Margin Businesses

Net profit margin is one of the key tools for determining the financial health of a company. The metric demonstrates a company's ability to convert sales into profits and also furnishes an insight into how well a company is run. Armaan Madhani explains how investors must properly analyse the various facets of profitability

- Armaan Madhani

'Tame Inflation, Avoid Recession' could possibly turn out to be one of the key themes for global financial markets in 2022. Fear of slowing growth has put enormous pressure on the markets. Brutal volatility continues to influence capital markets, which are exasperated by the threat that contractionary monetary policy by major central banks will position the global economy in the throes of a recession. Bears steadily continue to gain a stronger grip on Indian equity markets, majorly driven by concerns about the hurtful implications of a tighter monetary policy on the growth momentum, record inflation levels, mixed Q4 earnings season and weak global cues.

Stock picking is an uphill task. Especially in the current environment, where investors must be wary of businesses that are vulnerable to high levels of long-lasting inflation, supply chain disruptions, rising interest rates and incessant geopolitical crisis. A smart strategy for investors is to consider companies with robust earnings' potential that hold up better than others when the times get tough. These are companies that generate plentiful profits on a regular basis. A neat trick to identify such businesses is to scrutinize net profits or bottom line. To gauge the extent of profits, net profit margin is the ideal metric.

Net profit margin is one of the key tools for determining the financial health of a company. Net profit margin ratio is calculated by dividing net profit by sales revenue. The metric demonstrates a company's ability to convert sales into profits and also furnishes an insight into how well a company is run. Higher the net profit margin, the better is the financial health of a company as it implies larger profits relative to revenue. Net profit margin also, to a certain extent, determines a company's ability to pay dividends to its shareholders.

Pros and Cons of Profit Margin Ratio