Sales growth is an important gauge. But growing sales don't tell you whether a company is truly a top-shelf or bottom-rung player. And it doesn't tell you if a company might be slashing prices to move its inventory.
Profit margins can add several important dimensions to your research.
Sales provide capital to fuel a company's operations. Profits reveal how effectively the company achieves those sales. They also show how much muscle an outfit builds to reinvest in operations, to develop and market new products, and to offer employees incentives to innovate and excel.
To gauge a company's profits, take a look at pretax margins.
Pretax margins can be sliced and diced a number of ways, but aim to show earnings, before taxes, as a percentage of overall revenue. (EBITDA, or earnings before interest, taxes, depreciation and amortization, is a similar measure, showing a company's profitability minus the effects of accounting and financing strategies.) Margins can vary widely from industry to industry. But the ratio provides a good gauge of peer strength in any particular industry group.
Among fertilizer makers, for example, CF Industries (CF) generated a 45% pretax margin last year. That is well above Mosaic's (MOS) 26% margin and the 13% margin for Agrium (AGU). But it lagged Terra Nitrogen (TNH), a master limited partnership which sports a 64% pretax ratio.
Part of that difference is due to the companies' differing focus on nitrogen-based fertilizers. Nitrogen products have commanded somewhat higher prices this year, while the basic raw material, natural gas, has been unusually cheap.
Agrium is more diversified, with just over a third of its pretax earnings coming from nitrogen last year. Nitrogen was more than 90% of CF Industries' pretax take. Mosaic, on the other hand, is focused on phosphate and potassium-based fertilizers.
After-tax margins help dig a little deeper. In IBD's market columns, writers frequently point out a company's margin changes on a year-over-year basis.
CF's after-tax margin was 26.4% in the first quarter. That was only slightly below the fourth-quarter peak of 27.3%. Measured on a year-over-year basis, CF has increased its after-tax margins in four consecutive quarters.
Agrium has increased after-tax margins in eight straight quarters. Its Q1 after tax margin was 5.7%, down sharply from 11.9% in Q4 and well below the 21.6% high notched in Q4 2008. Again, CF is on better footing.
IBD's combined Sales Growth, Profit Margins and Return on Equity grade, called the SMR Rating, also incorporates margin strength. CF Industries, Agrium and Terra Nitrogen carry SMR Ratings of A. Mosaic's SMR Rating is a B.
