John Dorfman on Investing: Give Me Those Obscene Profit Margins |


The goal of business is not income or growth. It’s profit. If oil is selling for $80 a barrel and you can get it out of the ground for $50, you’ve got a good deal. If your oil is a mile underwater and costs $120 to extract, you have a bad deal.

That’s why I like companies with big profit margins. Obscene profits? All right, in my book.

Once a year, in this column, I feature companies that stand out for their profit margins (profits as a percentage of sales). I consider an 18% after-tax margin a brilliant result. Here are five stocks that I think fit the bill.

Cisco Systems Inc. (CSCO) has achieved an after-tax profit margin of more than 20% for nine consecutive years. It is the largest computer networking company in the world and is also active in cybersecurity and videoconferencing (WebEx).

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Cisco was once the darling of investors. It went public in 1990, increased its value more than a hundredfold, and had the highest market value of any company in the world in the early 2000s.

After the dotcom bubble burst in March 2000, Cisco plunged more than 80% in about two years. Since then, the recovery has been long and slow.

Today, the stock is selling for 16 times earnings – historically a typical multiple, but below average these days. (The market multiple is around 25.)

I like a ton of oil and gas stocks right now, as I think the industry’s recovery will continue to gain momentum. Like most of its industry, ConocoPhillips posted losses in 2015-2017 and in 2020. But lately it has posted an after-tax margin of around 19%.

While many oil and gas companies have taken on debt during the industry crisis, ConocoPhillips has managed to maintain a reasonable balance sheet. Currently, debt represents approximately 34% of the company’s equity. And its stock price seems quite reasonable to me, at nine times earnings.

Applied Materials Inc. (AMAT), based in Santa Clara, Calif., is the world’s largest manufacturer of equipment used to manufacture semiconductors. It has been more stable than most competitors in its industry, with profits in 14 of the past 15 years.

The company is heading for a sixth straight year with after-tax margins above 18%.

The bear case for the semiconductor industry is that personal computer sales have fallen recently and the shortage of chips used in cars is beginning to be resolved. However, I think the long-term trend is still to increase the use of chips.

Tech stocks have been trampled this year, and semiconductor stocks in particular. Still, I’m including three tech stocks in my five recommendations today.

I think the carnage in the sector has been exaggerated and the tech sector is where much of the growth and innovation in the US economy resides.

Dallas-based Texas Instruments Inc. (TXN) is the world’s largest analog chip maker. It also manufactures microcontrollers and calculators. The company has steadily increased margins since 2012 and posted an after-tax profit margin of nearly 44% last year.

Another stock that took it on the chin is Biogen Inc. (BIIB), a biotech pharmaceutical company. It’s dropped about 40% over the past year.

For a while, investors have been very excited about Biogen’s drug for Alzheimer’s disease, aducanumab. The clinical trial data was not strong enough to cause a Food and Drug Administration advisory panel to recommend approval. But the FDA approved the drug anyway, in a controversial decision.

My feeling is that investors are overly focused on this drug and not giving Biogen enough credit for the rest of its pharmaceutical line.

Before today, I had written 12 columns on this topic. The 12-month average return for my recommendations was 18.2%, compared to 14.8% for the Standard & Poor’s 500 Total Return Index. Eight of the 12 columns showed a profit but only three beat the index .

Keep in mind that the results in my column are hypothetical and should not be confused with the results I get for clients. Also, past performance does not predict the future.

My fat margin recommendations from a year ago suffered a 13.7% loss, slightly worse than the 12.2% loss for the Standard & Poor’s 500. Magnolia Oil & Gas Corp. (MGY) performed well, but Quidel Ortho Corp. (QDEL) and T. Rowe Price Group Inc. (TROW) suffered significant losses.

Disclosure: I own Texas Instruments personally and for almost all of my customers. I own ConocoPhillips and Applied Materials for one or more clients. A hedge fund I manage has call options on Cisco Systems.

Correction: Contrary to what I reported in July, Embecta Corp. (EMDC) is not debt free. He recently had $1.6 billion in long-term debt and $10 million in short-term debt.

John Dorfman is president of Dorfman Value Investments in Boston. He can be contacted at [email protected]


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