Investors are frequently told that high-quality businesses have high profit margins. US retailing giant Costco (US:COST) is an exception to this rule.
High profit margins are often a sign of a company’s competitive strength. In many cases, this is true. Companies with high margins often have a business that is hard to copy, which enables it to make large profits. They also tend to be safer businesses as fat margins give them a large buffer between profits and losses. Low-margin businesses can become no-margin businesses when times get tough.
However, there are often exceptions to general rules. Sometimes high margins are a sign that a company is charging its customers too much, which can create opportunities for new competitors. This has been true in the grocery sector, where incumbent operators have seen their profit margins whittled away by lean and agile hard discounters such as Aldi and Lidl.