A company may have a fat profit margin for two reasons. It may have first-mover advantage in a new field. Or it may provide something that people strongly want, whether that be a smartphone or a tasty chicken sandwich.
Either way, companies with fat profit margins are worth a look, especially if the margins are expanding.
The profit margin is the percentage of a firm’s total revenue that it keeps after all expenses. Profits can be reinvested in the business, used to pay dividends or used to buy back stock.
Here are five fat-margin stocks I believe are worth considering.
There’s a reason why politicians rail against the allegedly obscene profits earned by big pharmaceutical companies. This has been a highly profitable industry over the years, making products that people not only want but also need.
Pfizer Inc. (PFE) has a profit margin of 29% before taxes and more than 23% after taxes. It has a broad product line and worldwide geographic diversity. At about $36, the stock sells for 16 times earnings, which seems reasonable to me.
Although it’s only the fourth-largest U.S. railroad company, Norfolk Southern Corp. (NSC) stands out for its profitability, with margins of 35% pretax and 24% after tax.
The company operates in the East and Southeast. Traditionally, coal was a major cargo. As the coal industry declines, it has been able to increase other types of freight such as cars, chemicals, steel and lumber.
Since the end of the Great Recession in 2009, the stock has quintupled. It sells for 17 times earnings.
Gentex Corp. (GNTX) boasts margins of 27% pretax, 23% after tax. It makes self-dimming mirrors for cars and self-dimming windows for airplanes. The company has no debt, and it has increased its earnings consistently, but more slowly in recent years than a few years ago.
Several famed hedge-fund managers are in this stock (or were, according to the most recent filings). They include Jim Simons, Ray Dalio, Paul Tudor Jones and, most recently, Steven Cohen.
More speculative and more expensive is Corcept Therapeutics (CORT), a Menlo Park, California, pharmaceutical company. Its focus is regulating the level of cortisol, a hormone, in the body. It has a diabetes drug on the market, and clinical trials underway for several other drugs, including cancer drugs.
After more than a decade of operating in the red, Corcept turned profitable in 2016. The stock fetches 19 times earnings, which is more than I usually would pay but less than the market’s prevailing multiple of 22. Corcept’s margins are very high, at 34% before tax and 29% after tax.
Considerably cheaper is Occidental Petroleum Co. (OXY) of Houston, the sixth-largest U.S. oil and gas company by market value. Once famous for drilling in Libya, Occidental now has core assets in the Permian Basin in Texas. It still has operations in several Middle East countries and Latin America.
The market is treating all oil companies as poison. Occidental shares go for just eight times earnings. But there’s a 7% dividend yield, a pretax margin of about 25% and an after-tax margin of about 20%.
Last month, Occidental acquired Anadarko Petroleum Corp., using financing provided by Warren Buffett’s Berkshire Hathaway. It’s a high-risk move, but now seems like the time to snatch oil-patch firms while stock prices are down.
This is my 10th column on companies with fat profit margins (every year since 2009, with the exception of 2010). The average one-year return on my picks has been 17.2%, versus 14.7% for the Standard & Poor’s 500 Index.
Seven of the nine columns have shown a profit. But only two have beaten the S&P 500. The strong average return reflects big returns from my 2009 and 2014 selections.
Bear in mind that my column recommendations are theoretical and don’t reflect actual trades, trading costs or taxes. And past performance doesn’t predict future results.
My picks from a year ago were the worst in my nine outings. Four of my five selections fell, with an average loss of 18.4%, versus a gain of 3.0% for the S&P 500.
Disclosure: I own Pfizer for a few clients, and Occidental Petroleum for one client.
John Dorfman is chairman of Dorfman Value Investments LLC in Newton Upper Falls, Massachusetts, and a syndicated columnist. He can be reached at firstname.lastname@example.org.