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The Most Profitable Industries

December 05, 2012 | About:
tonyg34

tonyg34

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As value investors we are always searching for opportunities. Preferably in companies with above-average returns. What we are really looking for then are successful niches, companies with pricing power, consistent demand and low overhead.

It was with this simple agenda in mind that I decided to do a quick search for the most profitable industries. Fortunately for me, Forbes had already done the leg work.

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To be fair, these numbers are something of a snapshot, as the profitability of an industry ebbs and flows with the overall economy. And another thing to remember about profit margins is that they are not directly correlated with income levels. The industries listed above, and the stocks discussed below, may be very profitable on a percentage basis, but may not generate large revenue due to lack of scalability. In other words, most small businesses stay small.

Certified Public Accountants

They say there are only two certainties in life. And thus, CPAs enjoy the pricing power earned by highly specialized industry knowledge, absolutely stable and permanent demand, low overhead and repeat clients. Under the Sarbanes-Oxley Act of 2002, to become a publicly traded accounting firm, you may only provide external audit services. It would be considered a conflict of interest if you provided non-audit services. Consulting services are a big slice of revenue for these firms. So, unfortunately for us, even though this is exactly the kind of business we are looking for, this is not an investable idea.

Dentist Offices

A surprisingly good business is dentistry. Again we are looking at a business highlighted by specialized skills, constant demand, relatively low overhead, and repeat clients. Dentists benefit from some scalability, in that larger offices allow them to visit multiple patients at once while keeping overhead under control. On the down side, dentists do not exhibit much pricing power as switching dentists is quite easy.

Birner Dental Management Services (BDMS) is a successful roll-up business. The company acquires and manages dental practices. The theory is that the company is able to lower overhead by aggregating office expenses and managing inventory across multiple offices. It is a high return on equity business and pays a generous dividend.

Law Offices

Law offices also exhibit strong pricing power, if you've ever needed a lawyer you already know this. It was the inherent strengths of this industry that made Pre-Paid Legal Services (PPD) one of my best stock picks, prior to being bought out in 2011.

In the U.S., it is illegal for law firms to go public because of ABA Model Rule 5.4: Professional Independence, which prohibits firms from selling equity shares in law firms to non-lawyers. This interpretation of the rule was upheld when law firm Jacoby and Myers sued the state of New York for the right to sell partnership interests. However, there is at least one publicly traded law firm.

Slater and Gordon Limited (SGH), an Australian law firm, has paid a dividend every year of its existence.

Summary

I hope by now you have noticed a theme. All of these small businesses share three important characteristics that result in higher net profit margins.

1. Highly specialized skill or knowledge

2. Constant demand

3. Low overhead

I thought these were the most interesting ideas from the list, but they are simply a starting-off point for finding investment ideas. Investors are always encouraged to do their own due diligence.

Rating: 2.8/5 (4 votes)

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