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Margins, how much should they matter?

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May 31, 2012 – Comments (9)

I always think the thing that matters most is earnings, and future earnings.  Companies with wide margins tend to have much higher multiples.  It makes sense because there is more room for error.

However, if a company has margins of 10%, and it sees a way it can expand its earnings by 50% but in order to do so this additional expenditure would only have margins of 2%...wouldn't you want that as a shareholder?  Double my earnings, I don't care what the margins are.

How important are margins for you?

9 Comments – Post Your Own

#1) On May 31, 2012 at 1:06 PM, JaysRage (90.16) wrote:

Of course it depends.   How rock solid is that 2%?    Can the company consistently pass on costs to the consumer in price?   There's absolutely nothing wrong with low margins on high volume if the margin swings are small or zero.    

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#2) On May 31, 2012 at 1:48 PM, Frankydontfailme (27.51) wrote:

Right, low margins means low margin of error, what if the cost structure increases by 2 percent... can you pass off the cost?

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#3) On May 31, 2012 at 5:01 PM, leohaas (32.65) wrote:

You are 100% right. Companies that are managed for the top line rather than the bottom line usually do not fare well. May I remind the audience about Lucent Technologies under Rich McGinn for a prime example?

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#4) On June 01, 2012 at 10:42 AM, ikkyu2 (99.18) wrote:

It really depends on the industry, I think.  In a really capital-intensive business like, say, engineering consulting, or semiconductor R+D, I would hate to see my management go looking for opportunities to make a 2% profit margin.  It's too easy to stumble.  One engineer quits and the cost of retraining a new one suddenly wipes out your profits for the year.

If the business, on the other hand, is widget retailing - something with a traditionally low margin where the business is already optimized for lean performance and there are lots of interchangeable parts, no key employees, no huge capital expenditures, then it makes sense.  Retail, especially supermarkets; and especially restaurants are businesses that thrive on tiny margins.  One of your waiters or cash register operators quits, you just hire another the next day, no muss no fuss.

I was following BWLD in 2006 when the Asian 'bird flu' scare caused wing prices to go from $1 to $1.45 a pound in a very short time.  Suddenly BWLD has a huge expenditure to make inventory.  The margins for that year zeroed out and they failed to make any earnings.  (Which is why your dichotomy between margin and earnings is a false one; they're two ways of looking at the same quantity.)  Point being, though, that kind of thing doesn't usually happen in the restaurant business and it hampered BWLD's ability to compete and interrupted their growth plans at that time.  

Surprising; average fast food operating margin is 6%; BWLD's dropped to 0%; CMG and MCD sport a healthy 12% margin year over year, something no other restaurant chain can manage that I'm aware of.

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#5) On June 01, 2012 at 12:15 PM, Valyooo (99.55) wrote:

ikkyu,

Good points, thanks.  How did you know when it was time to jump back into BWLD?  I guess you can assume that scare was temporary, so it would not really affect long term growth.  So as long as they could survive the year without going bankrupt, I guess buying into a 8% or more dip (since you have to give up one years profits and annual stock returns is 8% a year) makes a good call?

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#6) On June 01, 2012 at 5:08 PM, ikkyu2 (99.18) wrote:

Honestly, Valyooo, you are going to laugh at how unsophisticated this decision was.  Peter Lynch in Beating the Street suggested that any time a budding, high-growth restaurant stock, which was expanding and still had plenty of room to expand, was available for a (debt-adjusted) P/E less than 20, it was a screaming buy.  His example was Taco Bell, which I gather he made a ton of money on.

BWLD has no debt so that was easy.  BWLD put in 8 quarters of earnings beats and its P/E (TTM) briefly dropped to 19; its forward P/E (which Lynch was talking about) was considerably less than that.

So I bought some at 58 not all that long ago.  It then put in a really massive earnings beat and hasn't been seen under 80 since then.

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#7) On June 01, 2012 at 5:10 PM, ikkyu2 (99.18) wrote:

The Gardners, btw, have been advising people to buy BWLD since about 2002.  They also advised not to let the wing-price burp scare anyone off.  They've been in this game for a while and man, did I ever argue against them at the time (05-06), but I have come to believe that they were simply correct and I was simply wrong.

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#8) On June 01, 2012 at 5:12 PM, ikkyu2 (99.18) wrote:

BWLD is that rarity, by the way; a non-capital-intensive, essentially fast food restaurant that serves alcohol (and they do mark it up considerably.)  They really started pushing alcohol and its markup in the wake of the wing price scare.  The morality of this aside, I think it's really good business and their margins have been a lot more *consistent* since then.

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#9) On June 01, 2012 at 8:12 PM, Valyooo (99.55) wrote:

I would not laugh at that rationale at all...it is just the kind of logic I like to use...I think our styles are pretty similiar actually.

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