Phil Fisher laid out fifteen points to look for in a common stock; three of them are directly related to profit margins. Calculated as net income divided by revenue, the profit margin is a quick way to determine which companies in an industry are most efficient (i) relative to the competition, and (ii) as a whole.

Does the company have a worthwhile profit margin?

To hammer the importance of this point home, you need not look further than traditional auto manufacturers.

Does the company have a worthwhile profit margin?

Auto manufacturers have historically low profit margins. MSN Money reports a 5-year industry average of just 3.4% for auto manufacturers versus 11.5% for the S&P 500. That is, for every dollar of sales at the auto manufacturer, just $0.03 ends up in net income. The rest is spent on costs of goods sold, operational expenses, etc.

Take, for example, General Motors. In its fiscal year ended December 31, 2007, General Motors reported $178.2 billion of automotive sales. To make the vehicles sold, GM reported "Automotive Cost of Sales" of $166.3 billion. Simple math would tell you that GM generated about $11.9 billion in revenue, after taking into account the cost of the materials to make the vehicles.

Here's the problem: In the three years leading up to the end of last year, GM had to spend an average of $13.7 billion on "Selling, General and Administrative" expenses — the costs to keep the lights on, to keep the salespeople motivated, to advertise, etc. $11.9 billion in, $13.7 billion out. Starting to see the problem?

When Margins are Slim

If your company doesn't have a "worthwhile" profit margin, it has a problem: When tough times surface (as they always do from time to time), weak margin companies will probably start burning cash rather than generating it. When things begin to turn around, your company's ability to generate cash will be delayed relative to its high profit margin competitors.

As your company begins to use cash rather than generate it, your ownership is in jeopardy. I'm not just talking about negative free cash flow; your company will have to sell assets, fire people, take on debt, and/or sell more stock.