Sales At The Expense Of Profits Doesn’t Work

This week I want to focus on Sales Growth and Profit Margins.

Everybody understands sales, but margins might bring up a few question marks.

So let’s start at the beginning: First and foremost, sales are THE most important thing to a company. Everything else stems from that. Without sales, there really wouldn’t be anything else to analyze. Sales Growth numbers show you how the company is growing.

However, just because sales are increasing, doesn’t always mean that profits are increasing too. Sales at the expense of profits does not work. So paying attention to Profit Margins is the next thing we’re going to look at.

Margin is simply a ratio, and the calculation is Net Income divided by Sales.

So, if a company’s margin is 15%, for instance, that means the company’s net income is 15 cents for every $1 of sales it makes.

But if a company’s expenses are growing faster than their sales, this will reduce their margins.

In general, a company with increasing margins is becoming more profitable and is better managed; i.e., their costs are under control.

(Take Dell (DELL) for example. Last week, Dell announced their second-quarter earnings. They put up an impressive increase in sales; up 11%. But they posted a negative EPS Surprise of -8.3%. So their sales increased pretty significantly, but it came at the expense of profits as their margins fell yet again. The stock on Friday dropped nearly 14% on the news. Further proof that sales at the expense of profits doesn’t work.)

Parameters for this week’s screen:

• 12 Month Trailing Sales Growth (Current / 1 Quarter Ago) >= their relevant Industry average. (Looking for the top companies in their industries.)
• Current Net Margin >= 5 Yr. Avg. Net Margin. (Steady to increasing Net Profits is what we’re after.)
• Current Net Margin >= Net Margin from 1 Quarter Ago. (If a company’s profit margin fell last quarter, there’s a chance it might fall yet again. So we’re excluding those companies whose margins fell in the previous quarter.)
• Zacks Rank = 1. (The Zacks Rank is one of the best, if not the best rating system out there. One of the main components to the Zacks Rank is Earnings Estimate Revisions. The whole idea being, companies that receive upward estimate revisions have a tendency of receiving even more upward estimate revisions. And this helps paint a solid picture moving forward.)

Here are 5 stocks that pass this screen this week:

Fuel Systems Solutions, Inc. (FSYS)
Gerdau S.A.y (GGB)
G-III Apparel Group, Ltd. (GIII)
Life Partners Holdings, Inc. (LPHI)
Steinway Musical Instruments, Inc. (LVB)

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Comment by Trevor

2008-09-02 19:43:55

Reminds me of all those 0% loans the car companies were giving to boost sales. Look what shape they’re in now.

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