Profitability Margin, Your One-way Ticket to Become Mega Rich!
The bull market has been presumably awakened after a long nap since the bankruptcy of Lehman Brothers in 2008 with the Dow Jones Industrial Average rising to its all time high of more than 14,500 points. The rise of the market, as far as I know, did not affect me in finding a good company. My years of experience in investing has taught me that a business with sustainable moat will continue to propel forward regardless of market fluctuations.
In finding a good business, I use a range of financial metrics to assist me in unearthing a potential gem in the Singapore, Malaysia, Indonesia and Hong Kong Stock Exchange. The beauty of financial metrics, based on a timeless value investing approach, can be applied in any market and any location.
One of the metrics that I often use is Net Profit Margin, also known as Earnings Margin. It measures and quantifies how profitable a business is. The higher the net profit margin compared to its peers or industry average, the better it is.
I found a few companies and made some reasonable amount of money by using this technique. And if you intend to use a similar approach, that is fine. You will make money too. But that is NOT the point of this article.
Over the time, Net Profit Margin, measured by highest margin alone, is incomplete. If you wish to make more money and find crystal clear gems, there is another aspect you should look at, measure the ability of a business to scale up – scalability.
Wilmar International, an agricultural commodity player, operates in a competitive sector and differentiates themselves from the rest of commodity players by integrating the entire palm oil value chain – from cultivation, milling, refining, processing, merchandising and distribution of a wide range of palm oil products. In short, instead of focusing only a high profit margin segment, the management created one of the most desired moats – economies of scale. Today, Wilmar is a multi-billion dollar company with annual sales of S$55 billion in FY2012. Its net profit margin is only 3%; net profit amounted to S$1.5 billion. That’s the power of economies of scale! You wouldn’t want to discount that figure ($1.5 billion) just because its profit margin is razor thin. Likewise, WalMart Stores Inc achieved a net profit margin of 3.6% in FY2012. Based on its revenue, US$469 billion, its net profit is US$17 billion! Once again, the figure is simply too huge to be ignored!
I’ve shown you that the scalability of a business plays important role in creating wealth to shareholders. But that’s not the ultimate point… Using a car analogy would help me to decode the actual secret to you.
When it comes to cars, Ferrari (owned by Fiat Group) might be voted one of the best car brands to own in town. Ferrari achieved sales of £2.25 billion with operating profits of £318 million in FY2011. In the same year, Toyota managed to achieve sales of US$189 billion and a net profit of US$4.3 billion. In comparison to Ferrari (double-digit profit margin), the net profit margin of Toyota stood at only 2.2%. Does that mean Ferrari is a better investment than Toyota? Nope, that is not the point. If you allowed yourself to view from another perspective – its absolute net profit amount, Toyota definitely stands out from Ferrari with its reported net profit in the billions of dollars. Both companies has its pros and cons.
Now, imagine Ferrari with its extremely high price tag on its cars, possessing a similar scale as Toyota. Voila, that’s the secret! Find any business with high net profit margins and large economies of scale and that’s your one-way ticket to become an investing tycoon.
Investing is not a rocket science. It is simple but not easy to find a good one. I am continuously scouting them. If you happen to know any companies that possess such amazing traits, I will be eager to get this one-way tycoon ticket from you. Do whisper me for that!Earning Disclaimer
“Please note that the material here is provided to you for general information and illustrative purposes only, or as descriptive case studies on how our value-investing principles may be applied. It is not intended to be and should not be construed as any form of general or specific financial advice. For the avoidance of doubt, we do not recommend or provide opinions on how or what you should or should not be investing in, and you should always do your own research and independent assessment before making any investment decisions, taking into account your own specific circumstances. If you require any financial advice on investments or any other financial matters, please consult the relevant professional financial advisers.”