When an investor researches companies to invest in he normally looks at different margins such as the gross margin, the operating margin, the pre-tax margin, and the net profit margin.
In any case, he is in the right path if he concentrates on the operating margin. The operating margin is the difference between how much a business makes and how much it spends to operate.
If a company makes at least 15% more than it spends, it’s probably gotten the attention of the investor.
Right then, there is another thing the investor has to know…
Last year, was the operating margin lower or higher?
How about the year before?
And the year before that?
The investor wants to confirm the margins follow an upward trend, which could happen due to various things:
- A strong and/or rising pricing force.
- A shortage of products; meaning the company makes fewer product than it can sell.
- Technological leadership.
- A move from lower-end to higher-end products.
- Growing productivity.
- The capacity to manage costs effectively.
The investor has to research thoroughly to find out what exactly is producing the higher margins; however, all of the reasons above are good.
In truth, with an operating margin that follows an upward trend, even if you don’t research further, you know that a business is running from a strong position.
Profit margins reach the heart of what make a business successful. Take retailers, for example.
During 2008, many retailers sold more than ever over the holiday season; nevertheless, they had to reduce prices to entice the customers and in consequence, their margins were crushed to the limit. In other words, sales went up but profits went down. This is what happens when margins take the wrong turn.
If you want to do the research for yourself, you can get the numbers from Reuters Finance online. Look for a specific company and access its “Ratios”. We wish you good luck!
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