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by: MartinSejas
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The subject of this last chapter is profit margin, a concept which is often not used in the most effective way for an investor's benefit. That said, it is still a digit frequently quoted and looked at by many investors when making investment decisions. The reasons behind this are explored.

Before answering this question, I will outline what a profit margin actually means just in case some people are not aware of the concept. Profit margins are obtained by dividing net income by net sales. This essentially shows what percentage of net sales becomes net income after taking into account expenses (including tax).

As a consequence, if the profit margin is high, then costs are being kept under control which is a big positive for all keen investors. A problem arises if the profit margin is low which effectively means that an increase in costs could place the company in danger of seeing its profits turn into losses.

Now, that all may seem pretty simple to understand, which is true. It's not difficult to see how profit margins can be useful in determining which companies to invest in. However, Warren Buffett uses profit margins in a different way to the typical investor and this is why his fortunes have not been necessarily typical.

Historical profit margins are the key behind the success Buffett has enjoyed. This basically means that you have to analyse the evolution of profit margins of a company to give you a good idea of the state of the company. During this analysis, 3 types of patterns can be observed and it's important to understand the meaning of each one.

A typical pattern observed is a stable profit margin over the time period chosen for the analysis. This can be both good and bad news for the investor. It is positive news for the investor if this is high because it means that any increases in expenses during that time have been absorbed and controlled well. It is negative news for the investor if this is low because it implies that the company has not been able to keep expenses under control over that period of time.

Another common pattern is that of an increasing profit margin over the time period chosen. This is obviously good news for any investor, but before making any decision to invest, it may be wise to go through other parts of the Buffett methodology explained in the 4 previous articles of this series.

The third type of pattern is a decreasing profit margin. This basically means that in your chosen period, the profit margins have steadily decreased. This is certainly not good news for any investor because it means that management has not been able to control increasing costs over time. However, as I said before, any company should not be discarded without analysing the company using other components of Buffett's methodology.

Overall, Buffett's successfully methodology is based on 5 principles, which are all fully outlined in my articles for your own benefit. Any investor which is not aware of his strategies would be foolish not to study them. That said, you should not limit yourself to Buffett's way of investing. There are many great and useful strategies out there, which I will be writing about in the next couple of days. Stay tuned!

About the Author

About the author: Martin Sejas is the owner of Stocks-And-Commodities.com, a leading stocks trading website dedicated to finding the best and the latest strategies and techniques for stocks and commodities trading. Its mission is to become the 'one-stop shop' on the best stocks trading websites and programs on the Internet.

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