Fisher Investments UK’s research analysts often see financial experts dissect myriad corporate metrics in an effort to choose which stocks to buy. The most prominent measures seemingly hinge on profits, like price-to-earnings ratios. However, based on our coverage of financial headlines, one measure doesn’t receive a lot of attention: gross operating profit margins (GOPMs). In our view, the lack of analyst attention gives GOPMs real power and makes them a useful metric for investors. Let us explain.

GOPMs, quite simply, are a measure of a business’s profitability before taxes, interest and other accounting manoeuvres. They aren’t new, and, compared to many other corporate metrics we have come across, they are quite straightforward. To calculate GOPMs, subtract the cost of goods sold from sales. Then divide that number by sales. The resulting figure – expressed as a percentage – is the company’s GOPM.

In our view, GOPMs matter because they hint at a company’s ability to absorb higher costs and remain profitable, even capable of self-financing investment in future growth. Firms with large GOPMs have the bandwidth to finance expansion without having to borrow from banks and investors. These margins could fund marketing, research & development and M&A (mergers and acquisitions), all without diluting shareholders’ stake through equity and debt issuance. GOPMs can also serve as a buffer, helping companies sustain profitability even if their costs rise or an economic downturn occurs. Companies with thinner margins, by contrast, may depend on credit to survive lean times.

Based on our research, firms with big GOPMs tend to be growth-orientated. These companies generally reinvest profits into their core business to fund expansion. Their earnings also tend to derive from long-term technological or societal trends, making them relatively less sensitive to economic growth rates. In contrast, value-orientated companies – which usually have lower credit quality and whose profits are generally quite sensitive to economic growth rates – tend to have smaller GOPMs and often rely on debt financing. During economic downturns, Fisher Investments UK’s research finds value-orientated firms’ sales often suffer and their earnings get hit harder than their growth-orientated counterparts, since the former have less of a buffer to rely on.

We think this information can be valuable for investors from a portfolio positioning perspective. According to Fisher Investments UK’s study of market history, growth stocks often do better in the latter stages of bull markets (long periods of generally rising equity markets). During these periods, we have found economic growth tends to slow whilst price pressures rise, and investors often seek companies that offer stability, steady growth, the ability to absorb higher costs and less economic sensitivity. Big GOPMs reflect those qualities.

From a geographical perspective, US stocks’ GOPMs average 34.0%, higher than global developed markets’ average of 30.7% – and well ahead of the UK (24.9%) and the eurozone (23.5%).i America’s relatively heftier GOPMs are tied to the country’s Information Technology and Communication Services sectors. Globally, these two sectors have the largest GOPMs (46.9% and 42.5%, respectively).ii But European and UK markets have pockets of big GOPMs, too. The eurozone Health Care sector’s GOPMs are 48.7% whilst its Pharmaceuticals, Biotechnology & Life Sciences industry boasts GOPMs of 59.8%.iii The UK’s Health Care and Pharmaceuticals GOPMs are even larger: 66.8% and 69.7%, respectively.iv In contrast, value-orientated sectors’ GOPMs globally, including Energy (16.1%), Utilities (16.6%), Industrials (22.2%) and Materials (27.1%), are all below the global developed market average.v

If investors are looking for quality growth stocks both in Europe and abroad, GOPMs are a helpful tool, in our view. Moreover, we think GOPMs have investing power because the consensus doesn’t consider them useful, based on our coverage of financial publications. We have seen analysts treat GOPMs as simple, antiquated and out of date – a relic in today’s allegedly more complex, data-heavy, algorithmic world. This overlooks how investors can use GOPMs to identify a certain type of investment style – in this case, growth companies, which our research shows are in favour in today’s market environment.

In Fisher Investments UK’s experience, an important tenet to successful investing is being able to see things differently than the consensus. If the consensus thinks GOPMs don’t matter, we think they can provide an edge to investors who can see the power in their simplicity.

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Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom.

Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.

i Source: FactSet, as of 11/01/2022. Gross operating profit margins of MSCI USA Index, MSCI World Index, MSCI European Monetary Union Index and MSCI United Kingdom Investable Market Index.

ii Ibid. Based on gross operating profit margins of MSCI World Index sectors.

iii Ibid. Based on gross operating margins of MSCI European Monetary Union Index, Health Care sector and Pharmaceuticals, Biotechnology & Life Sciences industry.

iv Ibid. Based on gross operating margins of MSCI United Kingdom Index, Health Care sector and Pharmaceuticals, Biotechnology & Life Sciences industry.

v Ibid. Based on gross operating margins of MSCI World Index sectors.