INVESTORS, passive and active alike, are heavily reliant on the counsel, guidance and advice of licensed finance professionals when making investment decisions.

While advice may differ and performance will be the ultimate arbiter of any direction taken, there remain three underlying but influential factors which aid in determining investment decisions and which form the subject of today’s submission. Margins call out to every astute investor, but not all necessarily answer.

For the purpose of today’s discussion, we will, for the most part, sidestep the difference between profit and cash flow.

Businesses are driven by margins. Net margin is calculated by dividing net profit by revenues, ie this determines how much of a business’s sales become net profit on their bottom line.

Sustained high net profit margins tend to indicate high levels of efficiency in business practice, while lower margins often suggest the opposite. It is gratifying to consider investing in a company whose revenues increase at a faster rate than its expenses.

This speaks volumes about its profitability, and implies very strongly that this entity has its act together and should be part of one’s investment portfolio. A reason in support of this belief is that it assures investors that this entity would have a longer shelf life in the toughest of times and is not likely to fall quickly. In an economy such as Jamaica’s, which hits in double whammies, with devaluation increasing administrative expenses such as one’s electricity bill (since oil is imported), whilst also increasing the business’s cost of sales via the importing of raw materials necessary for the production process (as a weaker currency makes imports more expensive), a need for a healthy net margin becomes paramount to withstand external shocks.

That’s a punch combination that Floyd ‘Money Team’ Mayweather would be proud of.

As a side note, if the level of accounts receivable also rises at a slower rate than revenue/sales, one most likely has a certified winner for the portfolio. These are a few factors considered when poring over thousands of investment options, which are sometimes located in unfamiliar territories, regions and continents.

One should always be mindful of the differences between profitability and cash flow, as profit cannot be taken off paper to settle the month’s payroll or to pay a supplier. That said, with balanced levels of inventories — not excessive, and not insufficient — receivables under control, and adequate cash reserves, the majority of the battle is won.

Net margins provide a safety net in the toughest of times, and should definitely be considered when investing in a security.

Speaking of a safety net, when assessing a company’s stock for investment, the topic of the margin of safety usually surfaces when in the throes of analysis. This can be interpreted in many ways, but Warren Buffett defines it appropriately as “When you build a bridge, you insist it can carry 30,000 pounds, but you only drive 10,000 trucks across it. And the same principle works in investing.”

Another description would be to define it as the difference between the present price of a security and what one believes is its intrinsic value, ie its true value. This could be determined via adding the assets of the business and subtracting the liabilities, but wouldn’t necessarily take into account the future value of the business which would be dependent on its sector and industry.

Let’s consider a business in the line of mobile phones. If all its competitors were in trouble, yet it generated 50 per cent of its gross profit from the sale of mobile phones, and the sixth version of its flagship product debuted and sold a record 10 million units on its debut weekend, wouldn’t the average analyst perceive it as having a great future? That company happens to be Apple (NASDAQ: AAPL), and mankind will use mobile phones for the foreseeable future to communicate.

As of today’s date of writing, November 21, 2014, there was still a reported wait for the purchase of the iPhone 6.

Generally speaking, it is helpful to buy companies closer to their 52-week low than high. However, recent history is replete with examples of companies that traded at their 52-week high and went on to trade even higher, which is a benefit of buying based on outlook.

Therefore, to conclude, it is beneficial to buy based on outlook, but also with a bigger margin of safety, ie as far away from its inherent price as possible. This is oftentimes referred to as ‘value investing’.

For the quarter ended 31 August 2014, Nike (NYSE: NKE) saw their revenues increase by 14.50 per cent and most importantly, net margin increase from 11.07 per cent for the quarter ended 31 August 2013, to 12.05 per cent for the August 2014 quarter. It should therefore come as no surprise to any reader that Nike is now trading at above US$98 per share, after an initially recommended buy price of US$42 in 2012.

Mastercard (NYSE: MA), also experienced similar growth in margins, as its net profit margin for 30 September 2014 was an amazing 40.55 per cent (2013 – 39.63 per cent) on the back of a 12.84 per cent climb in revenue from the corresponding quarter in 2013.

Given the place credit cards hold in every wallet and the role they will play in our culture for the foreseeable future as commerce becomes even more cashless, it is reasonable to believe that MA will be here to stay. The margins, of course, support it being in the buy territory. So with all that said, if a margin calls, will you answer?

— Ryan Strachan is wealth manager at Stocks & Securities Ltd