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I have been learning about how to read and understand a stock company's income statement and using those variables to determine the worth of the stock. My question is, what is a good profit margin for a company that would make it worthwhile to invest, 5%? And what are the most important indicators to look at when making decision's based on the company's fundamentals.

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Check for how sustainable is the profit rather than numbers only. –  DumbCoder Mar 2 '11 at 8:33
    
Also note that you can't just look at margin and earnings and other features of the business. Investment is buying future-money with present-money, so you need to look at the price you're paying. For example: right now, Apple is trading for $360/share. Good deal? Beats me - but! all else being equal, it'd be a much better deal at $180/share and a much worse deal at $720. This is why the P/E ratio is still such a big deal, for all that earnings statements can be manipulated. (That said, looking at margins is still a very good idea.) –  fennec Mar 4 '11 at 21:39

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up vote 8 down vote accepted

The short answer is that it depends on the industry.

  • Retail: usually have low margins, 3-5% being a goodish range; some of the value traders can be even lower. Margin here is nothing compared to volume. If you're selling bags of potatoes and making a 2% margin, that's fantastic as long as you can use the income from the potatoes you sold five minutes ago to buy the potatoes you'll sell in the next five minutes.
  • Manufacturing: margins tend to be higher on specialised, high-end goods and lower on mass-produced, highly-competitive goods; could be anywhere from 5-20%.
  • Mining/Extraction: oil, coal, gold, you name it, usually very good margins but nailed by high tax rates and the globally set prices, so some sources only good at certain price points. A well-managed company will manage these fluctuations. Margins can be from 25-90%.
  • Services: amongst the highest margins but often the most likely to suffer incredible crashes since competition is fierce and barriers to entry low. Margins usually around 40-60%.

In other words, margin alone - even in comparison to peers - will not be a sufficient index to track company success. I'll mention Apple quickly as a special case that has managed to charge a premium margin for a mass-market product. Few companies can achieve this.

As with all investment analysis, you need to have a very clear understanding of the industry (i.e. what is "normal" for debt/equity/gearing/margin/cash-on-hand) as well as of the barriers-to-entry which competitors face.

A higher-than-normal margin may swiftly be undermined by competitors (Apple aside). Any company offering perpetual above-the-odds returns may just be a Ponzi scheme (Bernie Maddof, etc.). More important than high-margins or high-profits over some short-term track is consistency of approach, an ability to whether adverse cyclical events, and deep investment in continuity (i.e. the entire company doesn't come to a grinding halt when a crucial staff-member retires).

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And the margin and the reason for the margin might vary from year to year for a company. Did they cut costs, or did they sell more? –  MrChrister Mar 1 '11 at 21:57
    
Yeah, including, "Did they just lay off half their staff to achieve a quick margin boost?" –  Turukawa Mar 2 '11 at 5:39

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