Using Net Margin as a Warning Sign

Hi friends,

In this post, I would like to share with a financial sign which will alert me to avoid investing in particular stocks.

Net Margin

From investopedia,

“Net Margin is the ratio of net profits to revenues for a company or business segment – typically expressed as a percentage – that shows how much of each dollar earned by the company is translated into profits. Net margins can generally be calculated as:

Net Margin = Net Profit/ Revenue

The net margin tells me how much does a company actually make from every $1 it collects from its customer.

Take for example an amazing company, Challenger.

Let’s take a look at its revenue , profits and net margin from 2004 to 2012.

2012 2011 2010 2009 2008 2007 2006 2005 2004
Revenue 337,258 316,864 240,999 191,599 168,003 136,089 92,311 77,497 75,478
Net Profit 16,199 15,639 13,663 11,056 5,298 7,059 4,532 3,792 2,874
Net Margin (%) 4.803148 4.935556 5.669318 5.770385 3.153515 5.187047 4.909491 4.893093 3.807732

As we can observe, it is an amazing company that consistently  increases it revenue at a 20.58% for the past 8 years.

Its profits also grew in tandem at a 24.13%!

By these figures alone, I am very interested to own a piece of Challenger.

But however, when i look at the Net Margin, it hovers around 3% to 5%.

This tells me that for every $1 Challenger collects from its customers, it makes a net profit of 3cents to 5cents. What happened to the other 95cents to 97 cents?

It goes into pay suppliers, rental, salary, taxes etc etc.

Would you like to open a business where you sell something for $1 and collect net 5cents in the end? Let’s inrease the numbers a little.

Sell you sell a laptop to a customer for $1000, you end up with $50. Is that a good enough margin for you?

Well, with all due respect to Challenger, it has done an amazing job at maintaining that margin despite increasing rental, salary and other costs of operations.  It probably also has other sources of revenue besides selling hardware and has point to retain customers. It probably is big and thus has economics of scale to bargain for better rates from suppliers.

Before-Apple

But my concern is that the Margin is so thin that it has little error to make mistakes. Should rental continue to increase, or should more competitions appear to compete for a relatively commodity like type of goods – laptops and electronics (personally I am not very concern WHERE I buy my electronics from), all I can say is that I personally feel based on the thin net margin that Challenger is in an industry with very stiff competition.

So I personally will look for businesses that have higher net margin of perhaps at least 10% or if the margin is not as high, as least have a very distinctively unique product and service to offer with stable costs of production.

Hope this sharing enriched you. I look forward to your comments and sharing.

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Mind Kinesis Research Team

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