When considering stocks to add to their portfolio many investors get caught up in looking for the next big thing. But for every Google, there are countless others that never make it to profitability. One way to protect yourself from these losses is to look for companies with fat profit margins, so that they can weather any downturn they might encounter.
One company all ASX investors will be familiar with is ASX Ltd. (ASX: ASX). Last month ASX released its results, giving us an earnings update for the first three quarters of the year. With revenue increasing 5.8% to $516.8 million, net profit after tax (NPAT) increasing 4.1% to $298.7 million and net profit margin increasing to 57.8%, it was a beautiful set of numbers. With the added bonus of a monopoly in some of its markets, ASX is unlikely to be put under pricing pressure in the near term.
Mid to long-term is another matter, with ASX facing intense international competition. Ranked the ninth largest exchange in 2011, the ASX is now ranked 14th in the world. Tony Osmond, head of corporate and investment banking at Citigroup, puts this down to delistings outstripping new listings, fund managers' short-term focus and low levels of capital raising. With investing overseas continuing to become easier and cheaper, ASX needs to take steps to retain its current listings and capture more of the new listings that are currently heading offshore.
The much smaller IMF Bentham Ltd (ASX: IMF) may have flown under the radar of many readers. IMF is the oldest and most experienced commercial litigation funder in the world and has an incredible 95% success rate. In February, IMF released its half-year results, with revenue increasing to 131% to $77.6 million, NPAT increasing 152% to $23 million and net profit margin increasing to 29.64%. While IMF's profit margin is around half that of ASX Ltd., it is miles ahead of the total market average of 7.84% and one of the juicer ones available.
Late last month, IMF released an investor presentation that included details on four recent losses and their possible impact. Of the four cases, three are being appealed but it is unlikely IMF will have such impressive results continue for the second half of the year.
Over the mid- to long-term, IMF is in a much better position, and unlike ASX, it currently has limited competition with only two other funds vying for multi-national leadership. A company like IMF Bentham is always going to have very choppy earnings, but with a growing case portfolio and international expansion well underway, IMF should be a good move for investors who are prepared for the volatility that owning these shares will entail. IMF is currently trading at 52-week lows and from here I expect to see market-beating returns.
High profit margins aren't the only measure of great companies, but when you are assured that the companies you own can go through lean times while still making substantial profits, it can help you with the "sleep at night" test.
