If you want to purchase stock in the consumer goods sector of the economy, look for a company with management that’s successful at maintaining or lowering the costs of goods sold while increasing sales and revenue.
A key sign of growth at a consumer staple is an operating margin that continues to rise. The operating margin measures the efficiency of a company’s pricing strategy by seeing the profits before interest and taxes are paid. The operating margin is the percentage of revenue that remains from the sale of a product after subtracting the variable costs of producing that product, including the cost of wages and raw materials:
Operating Margin = Operating Income / Net Sales
Operating margins vary from industry to industry, but in general, look for operating margins in the mid-to-high teens. A company can raise its margins in numerous ways, with the two most commonly used methods being:
Add new benefits to an existing product (increasing its value) and raise the price. Because the company doesn’t have to spend so much on developing an entirely new product, it can boost its profit without significantly increasing the cost of producing the product.
Add a new product line. If the company can launch a new product line by using, for the most part, the personnel and equipment it already has, it can do so cost-effectively.
In addition to carefully evaluating a company’s operating margin, look for the following positive signs:
Innovation: The launch of new products creates new revenue streams and gives the company a competitive edge until rivals begin to enter the new market.
A high barrier to entering the market: The barrier to entering a market indicates how easily competing firms and products can enter the market. A low barrier means this entry is pretty easy; because most consumer products are easy to replicate, these markets have low barriers to entry and most brands have a lot in common with their competitors. Look for companies whose products have a barrier to others entering the same market.
Access to international markets: Selling products to international markets gives a company the ability to continue growing sales even if the local market is in a downturn.
Better treatment at stores: Although evaluating how effectively a company gets its products to its customers is difficult, you can gain insight into the company’s relationships with its retailers by doing your own field research. The more powerful brands get better treatment and more attention at a retailer because of a strong brand-retailer relationship, which is a sign of competitive strength. Usually, the powerful products sit at the front of aisles, or on shelves at eye level.