Earnings growth is arguably the most significant factor investors look for when purchasing stocks. However, the profit margin is not far behind.
Profit Margin Defined
When discussed as a percentage, profit margin equates to the revenue a corporation receives after factoring in its expenses. For example, a 50 percent margin means that the entity in question generated 50 cents for every dollar of profit.
However, margin alone does not tell the whole story. Investors also consider other concerns like margin trends and where these occurrences stand compared to the company’s growth cycle. If the business spends more money to turn a profit, its margins diminish. That is not necessarily problematic, mainly if the organization generates lofty revenues.
Amazon.com
The e-commerce giant lost money for significant periods while building its infrastructure. That said, investors realized that its business model would ultimately yield weighty profits and fuel profit growth as time passed.
However, when a company grows gradually, its profit margin will expand as expenses fall about total revenue. Margin expansion, which is Wall Street speak for increased profitability, demonstrates a company whose stock may be ready for a northward climb. To a certain extent, margins show the quality of a company’s earnings.
Competition Matters
Regardless of trends, you must always compare a business’s margin to its competitors. Those clocking in above industry averages indicate whether the entity stands out or is simply run-of-the-mill. It is also essential to consider that average margins vary greatly depending on the specific industry the business operates inside.
You are strongly urged to look for a company’s after-tax profit each quarter. When researching an establishment, pay attention to that specific margin, which should be near or reaching its highest levels over the past few cycles.
Moreover, the figures should also be some of the industry’s best.
Additionally, do not sleep on annual pre-tax margins. IBD research has discovered that stock market success stories held average pre-tax margins of at least 18 percent before commencing price alterations.
The Nvidia Case
Nvidia’s shares traded between 40 and 50 during the second half of 2023. That said, its stock began traveling to new heights in January. From January to October 2023, the artificial intelligence computing company’s earnings grew 488 percent, 547 percent, 153 percent, and 101 percent per share per quarter, respectively.
At the same time, its pre-tax margin commenced at 15.5 percent and rose to 17.2 percent, 33.9 percent, and 46.8 percent each quarter. These margins also confirmed the company’s position as an industry leader. IBD’s database found that Nvidia ranks in the top three in pre and post-tax margins in its industry.
Examples From Other Industries
Even when comparing small-margin sectors, you should always place each company up against its rivals.
Sprouts Farmers Markets is a notable leader in the grocery store arena, demonstrating the top margins in said field. Its annual pre-tax margin of 5.7 percent and quarterly post-tax margin of 4.7 percent truly stand out. On the low end of the industry’s scale is Albertsons. This company’s figures are some of the arena’s lowest annual pre-tax and quarterly post-tax margins at 2.7 percent and 1.6 percent, respectively.
TJX Cos and Ross Stores win the margins prize when examining discount retailers. TJX’s annual pre-tax margin during the last fiscal year was 10.8 percent, and its post-tax margin was 9.7 percent in the previous reported quarter. Ross Stores enjoyed similar good fortune, with margins of 12.1 percent and 9.6 percent.