One way to judge the fiscal fitness of a company is by looking at the firm's net profit margins.

A company's net profit margin is found by dividing net profit by the company's sales.

For example, let's say a company has annual revenue of $100 million and net profit of $2 million. The net profit margin is 2% (2 million divided by 100 million).

As an investor, you want to own companies that are profitable. Examining the company's net profit margin provides a useful tool to benchmark the profitability of certain companies.

For example, would you rather own a company with a net profit margin of 5%, or 50%? Obviously, the higher the net profit margin, the better the company is in turning sales into profits.

As is the case with any financial ratio, it is the trend that's most important, not the absolute number. For example, a company in which annual net profit margins have grown from 2% to 10% over the last five years may be a better investment than a company in which net profit margins have fallen from 50% to 25% during the same time period.

What I like about net profit margin is that it provides an easy check for investors when considering companies to buy. With a few simple computations (all the information you need to compute net profit margin is available in the company's income statement), you can tell whether the firm's net profit margin is rising or falling. As a rule, you probably don't want to buy stocks where net profit margins are falling. Conversely, companies in which net profit margins are rising may be a sign of new and more profitable products or improved management efficiencies.