High, wide margins tempting
When a company's profit margins are fat, it indicates that the company is doing something special, perhaps even unique.
Fat margins, however, can attract competitors who want to muscle in on the action.
To make sure a company still has an edge, I like to look for companies whose profit margins not only are large, but growing. That probably means that it will take competitors awhile to jump over the moat.
Here are five stocks with wide profit margins that have gotten wider in recent years.
JP Morgan Chase & Co. (JPM), based in New York, is a beleaguered bank these days. In July, it agreed to pay $410 million to settle a case with the Federal Energy Regulatory Commission alleging that it manipulated the market for electricity. It still is licking its wounds from the $6 billion “London whale” trading loss of 2012. Now, the Justice Department and the Securities and Exchange Commission are investigating its hiring practices in Asia to determine whether the company engaged in any form of bribery.
Because of all that, the stock is cheap. It sells for only 8 times earnings and slightly less than book value (corporate net worth per share).
Despite the headlines, I believe Morgan is an excellent bank. It needs to fine-tune its risk controls and compliance procedures. But I have great respect for its CEO, Jamie Dimon. I consider the stock a bargain at current quotes and own it for some of my clients. Morgan's operating profit margin last year was nearly 40 percent.
Cirrus Logic Inc. (CRUS) of Austin designs and sells semiconductor chips, especially audio chips. The knock against Cirrus is that it is too dependent on selling to Apple Inc. and Avnet Inc., a big distributor. I might stand that argument on its head and say it is hard to imagine two higher quality customers.
Cirrus had an operating margin of 25 percent last fiscal year. The company is debt-free, and the stock sells for only 10 times earnings.
Firearms maker Sturm Ruger & Co. (RGR), with headquarters in Southport, Conn., posted record earnings last year, with an operating margin of about 23 percent. The perennial and present threat to the company is the prospect of stricter gun control laws. I favor such laws but think it unlikely that big changes will pass.
Sturm Ruger has been profitable in each of the past 10 years, including the recession years of 2008-09. It achieved record earnings last year and is expected to break that record this year. It, too, is debt-free.
Obviously, whether to invest in a firearms company is an ethical issue for some investors — just as other investors might have issues about tobacco, nuclear power, gambling, alcohol, strip mining or fracking. Such issues are for each investor to decide, but based on the numbers, Sturm Ruger looks like a buy.
Marathon Oil Corp. (MRO), an oil company in Houston, achieved a 39 percent operating margin last year. It is an exploration and production company, having spun off its refining operations as Marathon Petroleum Corp. (MPC) in 2011.
Marathon Oil has posted profits for 17 consecutive years and stayed nicely profitable during the recession. The stock sells for 15 times earnings.
My last pick is Schweitzer-Mauduit (SWM) of Alpharetta, Ga. It makes specialized papers for items such as cigarettes, battery wrappers and vacuum cleaner bags.
The company has turned a profit in nine of the past ten years and had an operating margin of slightly more than 20 percent last year. The stock isn't cheap, but isn't terribly expensive at 16 times earnings.
This is the fourth column I've written on stocks with wide and expanding profit margins. The results so far haven't been as good as those for some other series. On average, my picks have risen 14 percent, compared with 17.1 percent for the Standard & Poor's 500 Index. Two of the three previous sets of recommendations were profitable, but only one beat the S&P.
Performance figures for my column recommendations are theoretical and don't reflect taxes or trading costs. The results for column selections should not be confused with the performance of accounts I manage for clients, and past performance doesn't predict results.
I have faith that high and widening margins are a useful metric, so I plan to continue the series. I will report on the performance of today's selections next year.
John Dorfman is chairman of Thunderstorm Capital LLC in Boston. His firm of its clients may own or trade securities discussed in this column. He can be reached at firstname.lastname@example.org or 617-542-8806.