Many investors pay special attention to companies' net profit margins. The net margin, which is calculated by taking net income and dividing it by revenue, is basically the difference between a company's revenue and its total costs, including production, marketing and overhead.
Net margins tell a lot. If a firm's profit margin is increasing, that means the company is earning more for each dollar of output than it was in earlier quarters. A declining net margin can be a big red flag: The company is doing more to earn less.
Margins often drop when a new competitor comes on the scene and drives down prices for similar goods, or a when company invests heavily in a new product or sales effort. Sometimes firms have trouble recovering from competitive threats, while strategic investments can have sizable long-term benefits.
In either case, it's a good idea to determine whether a company is expected to recover quickly from a declining margin. Since higher margins are generally better, stocks in this week's Analyst Picks have net margins that have been increasing in recent years and are currently higher than the S&P; 500 index average, which is about 11 percent.
American Express, the finance company known worldwide for its credit cards and travel services, has a net margin of 11.9 percent, which is higher than the industry average and has improved from 9.8 percent over the past five years.
Of course, American Express consistently meets its long-term targets of 12 percent to 15 percent annual earnings growth and 8 percent annual revenue growth. And, Amex should be able to keep up that growth pace, thanks to some new products.
The company recently introduced its Blue card, which has an embedded smart chip that stores customers' billing information and makes it easier for them to shop online. Amex's most profitable division, the high-net-worth-focused American Express Financial Advisors, also is trained on growth.
The company plans to double the number of its financial advisors by 2008. And American Express has improved its online brokerage and full-service banking services as well, which should boost future profits.
Investors who buy American Express shares now should be prepared to pay up for the stock. Its trailing price/earnings ratio, which measures how expensive the stock is relative to its profits, is 29, which is almost double the financial-industry average.
But, given American Express' strong track record and bright future, the premium is probably justified.
Another interesting company with improving margins is WorldCom, the telecommunications company. In recent years, WorldCom's net margins have seesawed as profits were stung by merger-related charges. But the company's current margin is 11.9 percent, up from 10.6 percent in 1999 and higher than the telecommunications-industry average of 9.3 percent.
WorldCom was in the headlines last month when the Justice Department frowned on its planned merger with Sprint. Some investors may be concerned about WorldCom's prospects sans Sprint, but the company's growth outlook is bright.
Finally, if a roaring company is more your speed, check out Harley-Davidson, the motorcycle manufacturer. The company just reported better-than-expected earnings and has upped its bike-production targets for the year.
Harley's net margin also improved to 11.9 percent in the quarter, up from 11.2 percent for the trailing 12 months and 10.9 percent in 1999.
The company's shares are pricey, but with a brand name that's synonymous with quality and a consistent and promising growth story, investors may want to take Harley shares for a spin.