By Conrad de Aenlle
International Herald Tribune
The problem with doing something well is that people expect you to do even better next time. Corporate profit margins — earnings as a percentage of revenue — have been running close to all-time highs, but they can improve only so much.
High profit margins in any industry are an invitation for competitors to enter the marketplace and skim some of the cream. That puts a ceiling on margins in the best of times, and as the marked slowing of U.S. economic output in the first quarter shows, these are not the best of times.
That could make revenue growth difficult and profit growth more difficult still. Companies can also improve margins by cutting costs, but there are limits to how much leaner and meaner they can become before the quality of their products and services begins to suffer.
Some businesses will continue to expand their profit margins, even if economic growth remains tepid, by moving into fresh markets, introducing new products and services or because they still have scope to improve productivity and bring in revenue more cheaply than they used to.
Stephen Biggar, director of American equity research at Standard & Poor's, highlighted four constituents of his company's benchmark 500—stock index that fall into one or more of those categories.
Comcast, a cable-television service provider, is continuing to increase revenue strongly. The high fixed costs that are a hallmark of the cable industry, and the tendency of customers to hang on to their service no matter what economic conditions are like, should help to ensure healthy margin expansion, he said.
Department stores have been improving inventory control, Biggar noted. This means that merchandise lingers on the shelves for less time, generating higher prices. He said he expected the middle-to-up-market Nordstrom chain to be one of the biggest beneficiaries of the trend.
"Better inventory management makes stores more profitable," he said. "If you don't have to keep as much on hand, you don't have to discount as much." His other choices are Schlumberger, which is experiencing strong demand internationally for its oil field services, and Kellogg, a supplier of packaged foods that "should be able to withstand a slowdown," Biggar said, because it sells basic products and "should benefit from restructuring and cost cutting."
As a value investor, John Buckingham, chief investment officer of Al Frank Asset Management, is interested in finding companies that trade at bargain prices before he starts parsing corporate statements for evidence of exceptional growth prospects. But he pointed to several constituents of his portfolios that have been expanding profits and margins faster than the broad market and that are expected to keep doing so.
His list contains several technology names, including International Business Machines and three companies involved in semiconductor manufacturing: Texas Instruments, Applied Materials and Vishay Intertechnology. Buckingham's other selections are spread over a wide assortment of industries, like the chemical producer Du Pont; the railroad operator Norfolk Southern; Walt Disney, the entertainment conglomerate, and the delivery service FedEx.
Barbara Walchli, manager of the Aquila Rocky Mountain Fund, looks for margin growth among companies that are adept at developing proprietary products and technologies that can command higher prices. Two favorites are suppliers of health care equipment, Merit Medical and Ventana Medical.
Technology product cycles often coincide with ups and downs in margins, even for companies that produce the most elemental components of fancy gadgetry. Walchli said she expected Micron Technology, a manufacturer of memory chips, to benefit from Apple's introduction of the iPhone and from improvements to Microsoft's Vista personal computer operating system. The start of a product cycle tends to lift margins for chip makers, for example, by spreading their high fixed costs over a much greater number of chips.
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