We are concerned when operating margins are too high or too low relative to industry peers. An abnormally high margin could suggest that a company’s business is too good to be true – in other words, it is a fraud. Meanwhile, an abnormally low margin might suggest that a company is in financial difficulties.
We assume that operating margins are determined by the industry a company operates more than its geographic location. For example, trading companies tend to report medium average margins of less than 4%, while real estate companies have margins around 24%, as shown in Figure 75.
Our accounting screen is set to trigger a red flag when operating margins are in the lowest 20 percentiles or exceed the 80th highest percentile relative to its GICS industry peers, and/or when there is an abnormally large deterioration relative to the normal rate of change amongst industry peers over one and three years. This latter red flag is triggered when the deterioration in operating margin exceeds the 80th percentile relative to the change experienced by GICS industry peers between 2010 and 2015.
