Electronic companies can be great candidates for investment if they check all the right boxes, as the focus in the last few years has been on the technological advancements in computers and the internet. This has created a booming industry that has caused demand to surge for electronic components and parts. While some believe the industry remains inherently cyclical and is subject to sharp booms and busts, others feel the cycle has lengthened enough for most companies to be able to make consistent profits.
A previous article of mine had questioned whether electronic companies’ businesses had peaked. Though it may seem that many companies in this industry have seen weakening revenue and profit numbers on a year-on-year basis, it still seems worthwhile for investors to sift out the stronger ones from the weaker ones.
One method of doing so considers the gross and net margins of each company in order to ascertain which one can perform better during a cyclical downturn.
I’ll be using the same four companies as in my previous write-up, namely Venture Corporation Ltd (SGX: V03), Valuetronics Holdings Limited (SGX: BN2), AEM Holdings Ltd (SGX: AWX), and UMS Holdings Limited (SGX: 558).
I took the liberty of using the last three full years’ gross profit margins in order to determine consistency and look for trends. I also included the gross margins from each company’s latest half year (H1 2019) and computed the average, with the results in the table above.
UMS has the highest gross margin among all four companies, at an average of 55.6%. AEM and Venture also have fairly high gross margins at 35.3% and 25.2%, respectively, while Valuetronics has the lowest gross margin at 15%. Gross margin is an indication of pricing power, and from this analysis, it seems UMS and AEM have the highest levels of pricing power among the four. That said, it’s also important for investors to dig deeper into the products or services that each company provides as well as the part of the supply chain in which they are located in order to explain the difference in gross margin.
Net profit margin measures how effectively a company controls its expenses. Obviously, a higher gross margin affords the company more leeway and wiggle room to have a higher level of expenses while still generating a decent net profit for investors. In the table above, UMS is the obvious winner again as it has an average net profit margin of 28.4%, while Valuetronics has the lowest, at 6.8%.
Margins are but one aspect
While the findings above clearly point to UMS as the strongest company in terms of margins, investors need to also assess and analyse other aspects of each company. One other aspect is customer concentration risk, as this is prevalent in the electronics industry. Some companies may derive most of their revenue from one or two key customers, thereby enjoying higher margins than the industry average. Other companies may report lower margins but have a more diversified customer base, which helps to mitigate a possible fall in revenue and earnings during a downturn.
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The information provided is for general information purposes only and is not intended to be personalized investment or financial advice. The Motley Fool Singapore has recommended shares of AEM Holdings Ltd. Motley Fool Singapore contributor Royston Yang does not own shares in any of the companies mentioned.