Twaddell says his first stop in evaluating a company is usually the income statement. Most investors look here to see whether gross, operating and net income margins are in line with industry averages. "If not, it's a negative," says Twaddell. "Then again, it doesn't have to be the kiss of death. Many companies have not reached the critical mass on sales that will reduce the effects of fixed costs, or may be experiencing high costs because they're growing."
What is an income statement, you ask? Read Income Statement to get the facts straightened out.
Such was the case with Investors Capital. For the quarter ending June 30, 2000, the company's operating margin was a trifle thin at 2.8 percent. After all, firms with similar business models were booking as much as 8 percent. "But we incurred a lot of expenses expanding our business," says Murphy, "and we anticipate this investment will drive future earnings." Investors Capital's torrid revenue growth bears this out.
Next, according to Twaddell, most equity investors examine the composition of revenues. "They are looking to see if the revenues have gravitated to the higher-margin business and will probe the degree to which revenues are recurring in nature," he says. "Revenues which occur over and over again without the stimulus and cost of sales promotion are ideal because they increase the company's overall profitability."
On the expense side, Twaddell says, "ideally, there will be operating leverage, which means that as the business grows, expenses as a percentage of revenues will level off or go down." The absence of operating leverage does not mean the business will be unattractive to all investors, but it could be a defining characteristic. Adds Twad-dell, "Some investors shy away from companies that cannot achieve operating leverage."