Do operating margins matter to SuperStock performance?

When I wrote about Three small cap SuperStocks worthy of further research last year, a subscriber, sevenccc, responded by saying:

…there is one big but for all 3 from my perspective. Low Operating Margins. Does this not concern you? To me this largely invalidates the Quality scores, which are all 80+. Is that unfair?

This thoughtful comment has stayed with me. Are low operating margins a sign of a poor business to be ignored, or is that already in the price and then some? The good news is I’ve now been able to test this empirically.

Operating Margin

Before I go into the details, here is a reminder of what the operating margin is:

Operating Margin = Operating Profit / Revenue = (Revenue – Operating Costs) / Revenue

The operating profit excludes taxes and interest payments and allows investors to compare businesses regardless of how they are financed or conduct their tax affairs. A business with a low operating margin has a minimal difference between the revenue it generates and the costs of those sales. A low-margin business works very hard to eke out a small profit. It is likely to operate in highly competitive industries. Typical low-margin businesses include distributors, such as NWF...