One Up On Wall Street: How To Use What You Already Know To Make Money In

by Peter Lynch

Without getting bogged down in the technicalities, pretax profit margin is one more factor to consider in evaluating a company’s staying power in hard times. This gets very tricky, because on the upswing, as business improves, the companies with the lowest profit margins are the biggest beneficiaries. Consider what happens to $100 in sales to our two companies in these two hypothetical situations: COMPANY A STATUS QUO BUSINESS IMPROVES $100 in sales $110.00 in sales (prices up 10%) $88 in costs $92.40 in costs (up 5%) $12 pretax profit $17.60 pretax profit COMPANY B STATUS QUO BUSINESS IMPROVES $100 in sales $110.00 in sales (up 10%) $98 in costs $102.90 in costs (up 5%) $2 pretax profit $7.10 pretax profit In the recovery, Company A’s profits have increased almost 50 percent, while Company B’s profits have more than tripled. This explains why depressed enterprises on the edge of disaster can become very big winners on the rebound. It happens again and again in the auto, chemical, paper, airline, steel, electronics, and nonferrous metals industries. The same potential exists in such currently depressed industries as nursing homes, natural gas producers, and many retailers.