Sales growth is an important gauge when picking stocks. But sales mean very little if they don't produce a profit.
If a company has a 25% profit margin, then it nets 25 cents per dollar of sales. Your child's must-have toy of the season retails for $25 and only costs $5 to manufacture. That's a profit margin of 80%.
The higher the margin, the better. But you still don't have the entire picture until you compare a stock's pretax margin to others in the same industry.
For instance, Meta Platforms was one of the biggest losers in 2022, despite a 40% margin. Occidental Petroleum was among the biggest winners that year with pretax margin of 17%.
Thus, check a company's margins against its peers to get an apples-to-apples comparison.
A stock's profit margins should be accelerating as well. Like a stock's earnings per share, accelerating profits over the last three quarters can be indicative of a stock's potential strength.
You can find this in IBD MarketSurge by going to the list section of the tool and selecting the list panel tools (on the wrench icon). Then select Customize Column Layout, which will bring up a series of options. Under Margins & Ratios, click AT Margin Accel. Drag the box into the Layout Preview and hit Apply.
Use IBD's SMR Rating
IBD's proprietary SMR Rating does the heavy lifting for you. This data item combines into one simple A-to-E rating system, four fundamental factors commonly used by analysts:
- Sales growth rate over the last three quarters
- Pretax profit margins
- After-tax profit margins
- Return on equity (ROE)
Sales growth and after-tax margins are computed with quarterly figures, while return on equity and pretax margins are calculated using annual figures.
For the quickest way to find a stock's SMR Rating, use the IBD Stock Checkup. Enter your ticker and it will return with the stock's SmartSelect Ratings:
- Earnings per Share
- Relative Strength
- Accumulation/Distribution
- Sales, Profit Margins, and Return on Equity
- Industry Group Relative Strength
Each rating includes its rank within the industry group and component data. All information is color coded for easy at-a-glance analysis.
Your Day In The Sun
In April 2019, SolarEdge Technologies finished a cup base. Looking up its pretax margins, you would find 14% from the fourth-quarter 2018 earnings report.
Around the same time, another leader in the solar energy group, First Solar, had a pretax margin of -13%, meaning costs were higher than revenue.
While First Solar was beginning to drift sideways, SolarEdge finished a short handle shakeout and gapped up, hitting a 20% gain immediately following the early-May earnings report.
With that much cushion, you could have very easily held until August, when the stock jumped again. By January 2021, SolarEdge had topped at a 774% gain from the April 2019 cup breakout. First Solar ran up 74% in the same time.
This article was originally published Feb. 17, 2023, and has been updated.
