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.
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).