The topic of today is unusual and bizarre to an extent. It is an investment strategy that can be used by certain people to make their stock selections. This refers to investing in companies with a high profit margin. Is this a viable strategy? Does this strategy work?
All these questions will be answered. First, let’s understand what high margins mean for companies.
Companies with high margins typically have a low cost for goods and a high selling rate, which allows them more revenue. These companies have a very low revenue-expense ratio. They produce products at low costs and sell them at skyrocketing prices.
These companies are highly profitable and have a competitive edge in their industry. This competitive advantage could be due to a variety of factors, including high entry barriers, high research and development, patents and trademarks, long term involvement in the sector, and many others. These companies could even be market leaders in their respective industries.
Let’s now discuss whether these high-margin businesses are viable and how to invest in them.
You need a demat account to be able to invest in stocks markets with high margins. You can also invest in IPO once you have a demat account. If you want to know about the IPO, you can see here the Upcoming IPO List of 2021.
High margin companies will always be in competition with other players for a share of the profits. These industries are attractive to businessmen. They are less likely to survive the long-term.
Small companies that venture into new industries and prove highly profitable are often either cost-effectively acquired or undercut by larger companies. We can see the largest tech acquisitions today in YouTube by Google, WhatsApp, and Instagram by Facebook. These are all massive deals. The industry’s biggest players are determined to thrive and grow long-term. They will use any means necessary.
Only a few of the big players can survive on a high profit margin. Take the example of Google, Facebook and Apple. Because of the complexity and the amount of skilled human resources required, some industries can even have high profit margins. Companies may struggle to maintain such high margins because of the competition. They will need to invest in R&D and innovation to keep ahead.
Investors should consider the past history of these companies when making investments. Imagine that the company has had profits for a long period of time and is able to resist competition. These companies are likely to continue generating profits over the long-term. Investors should remember that companies with high profit margins over a long period of time will have a high share price and high PE Ratio.
These companies can provide huge returns for investors if they are held over the long-term. You might be able to invest in as many as 4-7 companies that have high profit margins. The return on investment from even one company could exceed the loss of other companies. Diversification is key as not all companies that you invest in will be sustainable over the long-term.
Warren Buffett and Charlie Munger are all Value Investors. However, they only invest in high-margin companies if the share price falls below their expectations. Peter Lynch coined a term for this: “Tenbagger” refers to an investment with the potential to increase 10 times its initial investment. These stocks have a high growth potential and a lower PE Ratio than the industry.
Coffee Can Investing is another strategy some people use to purchase such stocks. It involves investing in companies with a track record of success and then forgetting about them for the next 10-20 year. This strategy was developed in the USA, and has been very successful. Investors can also enjoy compounding their wealth. Coffee Can Portfolio was inspired by the American Old West. People would put their valuables in coffee cans to protect them.
It is hard to survive in an industry with high profit margins. Only a handful of companies are able to do so. Ask yourself this question before you invest in companies like these: “Does the company have high conviction it will grow and stay at the top for the next 15-20 years?” If yes, then invest in the company. Diversification is key to lower risk and better odds of success with these companies.
What are you waiting to do? This strategy is worth a try. Remember to let us know if you realize your investment after 10 years.
