Turnover is vanity, profit is sanity.
It’s one of the oldest truisms of business, and has served investors well over the centuries. Boast all you like of your sales growth, but if you’re not making enough of a margin, you’ll end up on the corporate scrapheap.
At times like these, though, an obsession with profit margins can be just as dangerous. Events such as Covid-19, 9/11 or the global financial crisis may require drastic action to keep businesses alive. Sometimes that costs a bit.
So, two of our best-run companies – Fever-Tree and JD Sports – both today reported profit margins had been rightly sacrificed to keep up sales and market share during the lockdown and its aftermath.
At JD, it was to keep getting trainers out to customers online while its shops were shut, with all the additional shipping costs that entails.
At Fever-Tree, it was because it shifted from selling its tonic through fancy bars to supermarkets and its less profitable US sales shot up.
JD’s share price got away with it, doubtless thanks to some skilful massaging of expectations by the investor relations team.
But Fever-Tree’s didn’t.
Investors were so spooked by the margin decline that the stock tumbled 3% at one stage.
That’s unfair in the extreme.
Sure, the shares have had a strong run lately, but to punish them when the company “only” makes margins of 46.8% for one short period seems absurd. Especially when it’s sitting on a big cash pile and has paid out a decent dividend.
Margins are already building back up now bars are reopening and a US factory now on-stream means it no longer has to ship the stuff across the Atlantic. Meanwhile, the American market is growing like topsy.
Fever-Tree is in the perfect spot to win from the long term growth in the popularity of high-end cocktails.
We should be raising a glass, not punishing it. Buy.