Why investing in high profit margin companies is always a good bet. Picture Getty
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Margin squeeze will be a key theme this reporting season amid rising inflation and a drop in pricing power.
Analysts have warned that the next 12 months will see margins come under more pressure as costs increase and household consumption contracts.
Just prior to the COVID-19 outbreak in 2020, profit margins around the world were at record highs. They briefly dipped when lockdowns were enforced, but surged again as waves of monetary stimulus were unleashed by governments.
But a very different world has emerged post the pandemic.
Runaway inflation, along with rising environmental standards and expectations, mean a new set of costs for businesses.
Higher rates dished out by central banks around the world also mean rising costs of funds for most companies.
Profits are a function of revenue and costs.
Profit margin is simply calculated by dividing operating profits by revenues.
In other words, it measures the percentage of each dollar received by a company that results in profit to shareholders.
For stock investors, it’s a well known fact that investing in companies with high profit margins is a good bet. Under current market conditions, choosing these stocks have become more important than ever.
Companies with higher profit margins give investors a wider safety margin.
Higher margins may suggest that they have effective control of their costs, strong brand recognition, or a superior product that can’t be replaced in the market.
It also indicates they have more resources available for reinvestment and growth.
On the ASX, stocks with some of the highest profit margins include fund managers. This is because fundies have low operating expenses, with their biggest overhead being salaries of employees.
Internet companies such as marketplaces also enjoy higher profit margins, along with monopolies like market operator ASX (ASX:ASX).
So do oil companies, because once their large offshore platforms are built, they have a low marginal cost of production per barrel of oil. Obviously, tens of billions of dollars in capital are required to build these giant projects in the first place.
Mining giants are also able to generate high profit margins due to economy of scale.
In the other end of the spectrum, low margin businesses typically operate in highly competitive, mature industries.
Retailers operate with some of the lowest profit margins due to competition, price sensitive customers, increasing operating costs such as rent, and volatile supply chain costs.
| Code | Name | Profit Margins | Sector |
|---|---|---|---|
| MQG | Macquarie Group | 71% | Financial |
| AIA | Auckland International Airport | 70% | Industrial |
| LYC | Lynas Rare Earths | 61% | Mining |
| ASX | ASX | 49% | Financial |
| PLS | Pilbara Minerals | 48% | Mining |
| IGO | IGO | 48% | Mining |
| PME | Pro Medicus | 48% | Healthcare |
| AKE | Allkem | 40% | Mining |
| WHC | Whitehaven Coal | 40% | Energy |
| WDS | Woodside Energy | 37% | Energy |
| Code | Name | Profit Margin | Sector | Market Cap |
|---|---|---|---|---|
| BRL | Bathurst Resources | 76% | Mining | $197m |
| AMA | Ama Group | 69% | Industrials | $123m |
| FZR | Fitzroy River | 66% | Energy | $17m |
| MAY | Melbana Energy | 61% | Energy | $287m |
| GUL | Gullewa | 58% | Mining | $11m |
| FNX | Finexia Financial | 56% | Financial | $11m |
| EPY | Earlypay | 51% | Financial | $57m |
| CTP | Central Petroleum | 51% | Energy | $39m |
| D2O | Duxton Water | 48% | Utilities | $184m |
| SHE | Stonehorse Energy | 47% | Energy | $7m |
| PTM | Platinum Asset Management | 40% | Financial | $939m |
| OEL | Otto Energy | 38% | Energy | $57m |
| CUE | Cue Energy Resources | 36% | Energy | $36m |
| BYE | Byron Energy | 34% | Energy | $83m |
| RND | Rand Mining | 33% | Mining | $69m |
| QAL | Qualitas | 33% | Real estate | $790m |
| CUV | Clinuvel Pharmaceuticals | 32% | Healthcare | $864m |
| NGI | Navigator Global Investments | 31% | Financial | $309m |
| ASW | Advanced Share Registry | 31% | Financial | $23m |
| JIN | Jumbo Interactive | 30% | Discretionary | $846m |
Bathurst is a coal producer with mining assets in New Zealand.
The company has been successful in managing its costs, enabling it to exploit demand and high coal prices and convert this into a strong cash position and profits.
In the last quarter, Bathurst’s exports continued their year-on-year growth, with pricing levels remaining high as concerns remain in the Australian market.
“Inflation pressures also remain, but we are confident that we can continue to manage costs and extract full value from the market in Q4,” said CEO, Richard Tacon.
Fitzroy River owns strategic non-operational investments, including royalty agreements centred around oil and gas production in the onshore Canning Basin in far north Western Australia and in the Bass Strait.
Fitzroy also holds several hard rock royalties in Australia and New Zealand.
The company says the ongoing Ukraine conflict continues to create instability in global oil and gas prices, and has the potential to impact the company’s royalty receipts.
In addition, Fitzroy says royalty receipts may be impacted by any interruption to or suspension of production from ExxonMobil & Woodside in the Gippsland Basin, and any prolonged interruption in production by Buru Energy (ASX:BRU).
Earlypay provides online invoice finance as well as asset and equipment financing.
The business is tailored towards SMEs (small to medium enterprises) with supply contracts with larger Australian companies.
The EPY stock has been listed on the ASX since 2010, and has a long history of paying dividends.
Earlypay has stated that one of its priorities is to enhance significant cost savings to improve Net Interest Margin across all products by more efficient use of its balance Sheet.
Duxton owns and manages a portfolio of water entitlements and assets, primarily located in the Southern Murray Darling Basin.
The company has said the prospect of a drier outlook caused by a likely El Nino event later this year would increase demand for its leases and forward contracts.
Duxton says a forward sale of water allocations is important to farmers as it mitigates their risk.
“Forward allocation sales act as a price hedging tool for irrigators, as they provide visibility to cost and supply of allocation for the year ahead,” it said.
Duxton is set to acquire 4,770 megalitres of Australian Water Entitlements from Treasury Wine Estates (ASX:TWE) for around $39m.
Qualitas is an alternative real estate fund manager focused in private credit and equity across commercial real estate sectors.
The company actively invests in commercial property assets, and has a fund listed on the ASX called Qualitas Real Estate Income Fund (ASX:QRI).
Its strong growth momentum of funds under management (FUM) has translated into the expansion of Group EBITDA margin, on a pre performance fee basis, by 6% on in the first half to 44%.
Jumbo offers its lottery software platform and lottery management expertise to the government and charity lottery sectors in Australia and globally, and by retailing lottery tickets in Australia and the South Pacific via ozlotteries.com.
Jumbo’s performance has been constrained by a poor run of Powerball and Oz Lotto jackpots, but investors have overlooked the company’s success in increasing its per-ticket commissions.
For FY23, the company expects its underlying EBITDA margin to be at the upper end of the original range of 48% to 50%.
Disciplined cost management including lower than anticipated lottery retailing marketing spend (due to jackpots) will be key to achieving these margins, the company has said.
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