Key Fundamentals: Sales, Margins, Return On Equity

Sales growth, profit margins and return on equity are vitally important in evaluating a company's health. This lesson explains the significance of these financial gauges and how to identify the companies with best numbers. 

It All Starts With Sales

Sales figures are a key measure of a company's strength -- or lack of it. Perhaps no other piece of financial information reflects growth better than sales: the money that comes into a company from products sold or services rendered. If a company is run efficiently, sales growth essentially drives earnings growth. Companies basically have two ways to increase earnings. They either increase sales, reduce expenses or ideally do both. Although a well-managed company controls expenses, healthy sales are the main engine for growth.

When you search for the best stocks, you want a company to have strong sales growth to support its earnings growth. Think of sales growth as the foundation under your house: if it is loose, it's not as stable as one with all the structural elements in place. When you see a company increasing its sales, it's telling you its business is drawing larger demand and is structurally sound and prepared to expand and generate the earnings capable of boosting its stock price.

Demand is driven by a number of factors, including larger numbers of customers, customers increasing their purchase volume, introduction of new products, expansion into new markets and the improvement of existing products.

The top-performing companies show consistent double- or triple-digit sales growth. It's even better when the percentage growth rate increases quarter after quarter. Such acceleration is the hallmark of quality growth companies. They reflect a well-managed organization. Take a look at some companies that have done just that:

Nokia

Nokia began a 630% jump from March 1998 through December 1999 and continued rising into 2000 after the wireless-phone maker reported sales gains of 9%, 12% and 19% in the three quarters leading up to the big move. Earnings were rising sharply during this period, too.

Home Depot

Home Depot made a 698% move from June 1982 to June 1983. Its sales grew 104%, 158%, 191% and 220% respectively over the four quarters leading up to this major stock-price jump.

EMC Corp

EMC, the maker of memory chips, rose 512% from September 1992 to October 1993 as sales in the four quarters before this huge move rose 30%, 46%, 54% and a hefty 267%.

How high should sales growth be? The three most recent quarters should each have strong sales growth of at least 25% compared to their year earlier quarters. Otherwise, sales growth should be accelerating in the last three consecutive quarters.

Investor's Business Daily's earnings reports include the sales figures for every company releasing its quarterly results. Up and down arrows show if sales are higher or lower than the previous quarter.

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