Unless you are a short-term trader, finding a company that had a good year or half year yet turns out to be a one-hit wonder isn't really going to help your returns a great deal over time. Yes, you may get an initial gain in share price, but if the market turns and you're not quick enough to sell, your paper profit may go away.
I've found that companies with above average net profit margins are in businesses that have competitive advantages or can charge a premium for their products or service. Those advantages may be a strong brand name, barriers to entry for competitors, specialised processes or unique products.
Unless your stock is like Wesfarmers Ltd (ASX: WES) or Woolworths Limited (ASX: WOW), which work on tight margins yet have a majority of market share to defend against rivals, regular companies need higher profit margins to spin more money for further growth.
I have made a list of three companies that could satisfy that desire for fat profit margins and increasing earnings per share. That gives more company earnings for each dollar of revenue and more money to roll back into the business.
One fund management company that stood out in 2013 was K2 Asset Management Holdings Ltd (ASX: KAM). 2012 was a tough year with a net loss, yet it popped back up in 2013 with about a 36% net profit margin. That was more in line with 2011's net profit margin of around 37%. Underlying net profit returned to a level similar to previous years.
Energy Developments Limited (ASX: ENE) provides remote area energy solutions as well as low greenhouse gas emission energy production. Its revenue growth has trended upwards steadily over the past nine years.
In the last two years, underlying net profit margins have been over 10% and rising. Since late 2012 its share price climbed from about $2.50 to $5.
This last one hasn't been in the financial news a lot recently, but it is still a good company and popular brand. ARB Corporation Limited (ASX: ARP) makes and retails off-road vehicle accessories like roof racks and bullbars. Looking at its smooth revenue and profit growth since 2004, you wouldn't have guessed that there was a global financial crisis at all.
Since 2010, net profit margin has been about 14% annually and earnings per share rose from 46.3 cents per share to 58.4 cps.
Foolish takeaway
Higher profit margins also give businesses a buffer in case an economic downturn occurs. Lower margin competitors could get squeezed out while big margin companies can still make a decent profit.
