Profit margin is the theme of this final article in the series about Value Investing which is a concept that is commonly underutilised in finance today. Nevertheless, profit margin is something that all investors tend to look at when decide which stocks to invest in. The reasons behind must be understood.

Before outlining the reasons behind focusing on profit margins when making investment decisions, I find it ideal to explain what “profit margin” actually means for those who are new amateur investors. Basically, profit margin is written as a percentage which refers to the proportion of net sales that becomes net income after all expenses are taken into account, which normally includes tax.

As a result, a high percentage (high profit margin) simply indicates costs are being controlled well by management. This is what all investors would want to see in a company. The opposite is also true. A low percentage (low profit margin) is largely negative and implies that an increased in costs could potentially eliminate profits and create net losses for the company.

The above explanation clearly demonstrates how advantageous it can be to be aware of the profit margins of a company. Nevertheless, Warren Buffett has his own way of using profit margins which have brought him so much success over the years.

Historical profit margins are the key behind the success Buffett has enjoyed. This basically means that you have to analyse the evolution of profit margins of a company to give you a good idea of the state of the company. During this analysis, 3 types of patterns can be observed and it’s important to understand the meaning of each one.

One common pattern is a profit margin that is stable over the time period you have chosen, whether it be 5, 10 or 20 years. Overall, if this number is high it indicates that the company has been successful in controlling changes in expenses. If it is low, then controlling expenses is still a challenge for the company.

Another common pattern is that of an increasing profit margin over the time period chosen. This is obviously good news for any investor, but before making any decision to invest, it may be wise to go through other parts of the Buffett methodology explained in the 4 previous articles of this series.

A final common pattern is that of a decreasing profit margin over the time period chosen. This is evidently bad news for any investor and it is highly recommended that investors stay away from companies which have this characteristic. Nevertheless, it would be premature to say that such a company is not worth investing in without looking at other parts of the Buffett methodology.

In conclusion, the methodology used successfully by Buffett is something that all investors should study, all of which are outlined in this article and the preceding articles. One would be crazy to not learn something from the richest man in the world. However, there are many other strategies out there which have been successful. Watch this space for many more great articles on stock trading strategies.