Profitability may be a critical criterion for investors when they're assessing a company's investment value.

Unsurprisingly, companies that generate higher profits are more likely to catch some investors' eyes.

When gauging a company's profitability, there are three main metrics to consider: gross profit, operating income, and net income.

In this video, we will focus on how analyzing the net income will help you to assess a company's profitability.

Net income, also known as net profit, is a key measurement of profits.

Simply put, net income is calculated as revenue minus all expenses and costs.

Many US stock investors watch this metric closely because a company that continues to expand its net income is attractive.

Also, some analysts use net income to calculate their earnings per share (EPS). This is a widely used metric for estimating corporate value.

So how to analyze net income? Generally, there are two approaches.

On the one hand, we can look at it in absolute terms and how that changes over time.

If a company consistently loses money on an absolute net basis due to stagnant or low operating revenue and high production costs and expenses, its stock may appear unattractive to investors.

If a company sees its net loss shrinking or its net profit rising, we may consider calculating the growth of its net profit to see how it changes over time.

Generally, a company with accelerating net income growth may kindle investors' interest.

Let's take a look at an example:

This chart shows Microsoft's net income for the fiscal years 2013-2022.

For the first five consecutive fiscal years (2013-2018) in the shown period, the tech giant's net income delivered little meaningful growth.

But growth came soon after. In 2019, its net income rose by a staggering 136.8% and grew more than 10% for the next three fiscal years.

If you're performing your analysis during earnings season, you can compare the newly released net income to the market estimate.

Analysts often divide net income by the number of shares outstanding to get EPS (earnings per share)

a common profitability metric mentioned earlier.

If the EPS figure beats the market's estimate, the stock price might go up in the short term.

Conversely, if the actual number missed the estimate, the stock might move downward.

Note that when calculating the growth of net income you need to remove the impact of non-recurring items.

For example, the proceeds of a manufacturing company from its property sale or stock investment are considered a one-time financial gain.

So when you analyze net income, you need to remove profits that are not derived from the company's ongoing operations.

Another approach is to analyze net income on a percentage basis and observe how it changes over time.

The percentage, known as the net margin, is calculated by dividing net income by revenue.

It is a key indicator of a company's profitability, and it also shows how competitive the company is overall.

Many profitable companies have relatively high net margins.

For example, the average net income of the top 10 US-listed companies by market cap was roughly 23% for the fiscal year 2021.

When analyzing a company's net margin, you may compare it to its competitors.

In the same industry, a company with a higher-than-average net margin tends to have more competitive advantages and can likely generate more profits from its sales and also better contain its operating costs.

For example, when the economy cycles into a recession, companies in a cyclical industry, an industry whose capabilities to generate revenue are tied to the business cycle, with a low net margin, may be unable to weather the storm.

However, companies in the same industry with a higher net margin might keep making money and are more likely to survive this cyclical bust.

Meanwhile, we may also look at how a company's net margin changes over time.

If this ratio is on the rise and reaches a satisfactory level, the company may become more attractive to investors.

We may take a step further to consider the potential drivers of a rising net margin.

This may include core products' price increases, higher profits from lucrative businesses, and lower costs and expenses.

Understanding what's behind a rising net margin can help us identify its potential trend.

Again, let's look at Microsoft's net margin.

The company's net margin rose dramatically from 15.02% to 36.69% between the fiscal year 2018 and 2022,

partly because its cloud service yielded higher profits, and because its SG&A and R&D expenses were on the decline.

Figuring out the causes of a rising net margin can help us further analyze a company's potential performance in the future.

To sum it up, net income is a key profitability metric used by many investors when making trading decisions.

We can analyze either net income in absolute terms and its growth or net margin and the trend to better understand this indicator.