Profit margins

[earthtodan]

My buddy and I have two views on profit margins. I like seeing them high, he likes seeing them low.

His view is that high margins are a vulnerability, and leave lots of room for price compression due to competition, etc. A high margin company can't gain much more by margin expansion. Whereas if a company can operate and grow and return cash to shareholders with low margins, then there's plenty of room for margin expansion, and more profit.

My view is that high margins represent safety, and low margins are dangerous. If a company runs on only 10% gross margin, then if its fixed costs increase 1%, its profit decreases almost 10%. Whereas if a company has a 90% gross margin and costs increase 10%, profit only decreases 1%. For example SBUX wasn't hurt that bad when coffee prices spiked 10% because the cost doesn't represent a large slice of revenue per sale.

Thoughts?

[cannew]

A lot has to do with Sales Volume. If a company can generate enough volume than a lower profit margin will pay off. That's why so many companies offer coupons. When a restaurant offer a Buy One, Get One Free coupon, it obviously cost them twice as much, but the volume and possibly other items added offset the extra cost.

[Dividend Watcher]

To be honest, I've never paid much attention to margins, gross or net. There's a wide stretch between gross profit and net profit that a company can waste money on.

It seems to be true that higher margin businesses tend to draw more competitors to the market but it depends on how those competitors want to operate. Using your example, if someone came to market with a high quality coffee business in relaxing environments but wanted to compete on price, I believe SBUX may have a tougher time of it. Fortunately, most of its competitors (the real ones --not McDonalds -- which I believe are regional at best) have decided to just fill in the holes of SBUX presence and enjoy similar margins.

I prefer to focus on sales & earnings results along with the dividend record. As long as the company can give me a acceptable return, I'm happy.