The 5 Keys To Stocks Trading Success: Profit Margins | Investing

By MartinSejas
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Profit margin is the theme of this final article in the series about Value Investing which is a concept that is commonly underutilised in finance today. Nevertheless, profit margin is something that all investors tend to look at when decide which stocks to invest in. The reasons behind must be understood.

Before outlining the reasons behind focusing on profit margins when making investment decisions, I find it ideal to explain what "profit margin" actually means for those who are new amateur investors. Basically, profit margin is written as a percentage which refers to the proportion of net sales that becomes net income after all expenses are taken into account, which normally includes tax.

Therefore, a high profit margin means that the company is controlling its costs very well, which is what investors all look for. On the other hand, a low profit margin indicates a low margin of safety meaning that a decline in sales could quickly erase profits and result in a net loss.

Now, that all may seem pretty simple to understand, which is true. It's not difficult to see how profit margins can be useful in determining which companies to invest in. However, Warren Buffett uses profit margins in a different way to the typical investor and this is why his fortunes have not been necessarily typical.

Historical profit margins are the key behind the success Buffett has enjoyed. This basically means that you have to analyse the evolution of profit margins of a company to give you a good idea of the state of the company. During this analysis, 3 types of patterns can be observed and it's important to understand the meaning of each one.

A typical pattern observed is a stable profit margin over the time period chosen for the analysis. This can be both good and bad news for the investor. It is positive news for the investor if this is high because it means that any increases in expenses during that time have been absorbed and controlled well. It is negative news for the investor if this is low because it implies that the company has not been able to keep expenses under control over that period of time.

The second type of pattern is an increasing profit margin. This basically means that in your chosen period, the profit margin has steadily increased. This is great news for a budding investor, however, before choosing to invest in such a company, it's recommended that you completely understand the other components of Buffett's methodology before making a decision which are explained in my previous articles.

A third typical pattern observed is one where the profit margin has steadily decreased during your elected analysis time frame. This implies that the company has been unsuccessful in controlling rising expenses over time and is largely negative news for investors. That said, it would still be wise to look at the other 4 component of the Buffett methodology before making a final definitive decision.

Overall, Buffett's successfully methodology is based on 5 principles, which are all fully outlined in my articles for your own benefit. Any investor which is not aware of his strategies would be foolish not to study them. That said, you should not limit yourself to Buffett's way of investing. There are many great and useful strategies out there, which I will be writing about in the next couple of days. Stay tuned!

About the Author

About the author: Martin Sejas is the owner of Stocks-And-Commodities.com, a leading stocks trading website dedicated to finding the best and the newest strategies and techniques for stocks and commodities trading. Its mission is to become the 'one-stop shop' on the best stocks trading websites and programs on the World Wide Web.

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