Successful companies don't have to earn high profit margins; in fact many great companies don't. But higher margins do afford a company more breathing space if there is a sudden down turn, and when combined with massive volumes can act as rocket fuel to investor returns.
With that in mind, and using industry average data from New York University, here is a selection of four companies from industries with among the highest operating margins. Operating profit margin (EBIT/sales revenue) was chosen because it is a good indicator of how successfully management have been able to create income from the company's operations.
Computer software – average margin 30%
Software production can take advantage of very low marginal costs. That means once the initial product development has been completed, the cost of reproducing each additional unit are minuscule. With the rise of cloud computing, the marginal cost can be close to zero. For the 2012 financial year, Melbourne-based financial software company Iress Limited (ASX: IRE) generated an operating profit margin of 27.3%.
Gaming/entertainment – average margin 19%
While the gaming industry pours huge amounts of money into regular refurbishments and luring 'whales' who can win or lose millions of dollars at a time, casinos have statistical win ratios that average out over an operating period in the house's favour. That is in addition to the margins from food, drink and other entertainment like stage shows. Crown Limited's (ASX: CWN) 2012 operating margin was a healthy 18.5%.
Beverages – average margin 20.7%
It's hard to imagine an individual product with a higher profit margin than bottled water and since most other beverages like soft drinks, juice and beer are made up largely of water, the per-unit cost of production can be tiny. Combine low cost with massive volumes, like those achieved by Coca Cola Amatil (ASX: CCL), and you have a powerhouse company. Where high margins usually mean a flood of competitors keen for a piece of the action, CCL's unrivalled brand and distribution network give it a significant advantage. In 2012 CCL had an EBIT of $895.5 million, and total revenues of $5,097.4 million, giving the company an operating margin of 17.6%.
Telecommunications – industry average margin 20%
The telco companies that provide the access to phone and Internet services we rely on everyday also have low marginal costs for additional users after an initial big investment in the required infrastructure. Current share market darling Telstra (ASX: TLS) had an above-average margin of 22.8% in 2012.
Foolish takeaway
High margins are good, but investors need not restrict themselves to such industries. Retail food sales (supermarkets) are among the lowest margin operators, but have been among the best performers on the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) over the long term because of economies of scale and strong cash flows. Woolworths (ASX: WOW) for example had a 2012 operating margin of just 6.5% on the supermarket division of its business (including liquor), but shares have risen 35% in the last 12 months.
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The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Regan Pearson does not own shares in any of the companies mentioned in this article.
