4 Reasons Why A Company's Big Revenues Can Be Deceiving

About six years ago, I bought a stock at $5 a share that I later sold for more than $30 per share. That's a 500% increase.

Not bad, right?

Well, it so happens it's in an industry that has outsized sales -- in this case, $600 billion projected for 2013, according to an industry association. But I've long since found that great sales are not enough.

What's the industry? Airlines, where major U.S. airliners fly at more than 80% capacity and not-quite-out-of-bankruptcy American Airlines is boasting record sales for July.

Pretty impressive, you say? Not so fast.

The International Air Transportation Association also reported a 1.6% profit margin for the industry -- the after-tax profit is $10.6 billion and the revenue stream is highly dependent on rises and falls in fuel prices.

Still impressed?

That's not to say airlines are a bad investment. It's just that you need to look at more than sales revenue. Here are 4 things you should know about big-revenue companies before you invest:

1. Revenue Is Different Than Profit.

Revenue is just straight sales. Profit is the amount of money left after expenses have been deducted. For instance, airlines have labor, fuel and equipment costs in addition to other expenses. Before a dime is shown as profit, all expenses must be subtracted from revenue. "It is not what you make it is what you keep," Rob Seltzer, CPA and personal financial specialist says.

2. The Profit Margin Is What Matters Most.

Profit margin is the percentage of revenues that is actually profit. The airline industry spent well over $600 billion to earn about $10 billion. Seltzer says, "Sales are great, but if your margins are not good and your costs are too high relative to your revenues, then you have problems."

3. One-Time Large Purchases Can Have A Huge Impact.

Airlines have to buy big items like, you guessed it, airplanes. A one-time purchase such as an airplane can impact profits greatly. Therefore, the next quarter's profits could be much better. Always compare revenues and profits with a previous quarter, preferably one from the season the previous year.

4. Revenue Can Rise And Fall For Many Reasons.

"One thing I would look out for is this: "The company's bottom line [profit] looks better than past year, but sales revenue is down," says Michael Eisenberg, CPA and personal financial specialist. "How could that be? Expenses have been cut more than sales are down." If expenses were cut because new planes are more fuel efficient or gas prices dipped, cutting expenses has a positive effect on your investment — but not cuts in wages.

"Bottom line: More people out of work or more people with fewer working hours," he says. "That could spell trouble in the bigger picture for the economy because people have less money to spend." A worsening economy can mean less people flying or buying products and even lower profits.

The Investing Answer: Pick companies to invest in based on whether the price of the stock is worth it. When I bought airline stock that I sold for six times the value I bought it for, I looked at previous stock prices as well as projections. I also did it with a clear understanding of profit margin and expenses that did and could incur.

It's important to discuss with a finance professional, CPA or financial planner, why you want to invest in a company with high revenue but not necessarily high profit margins. They may reassure you that it's still a great investment or convince you to invest in a mutual fund or other stocks instead. Just make sure he gives you the reasons for his decision so you can make your own.

by Christian Hudspeth What's even better than earning rewards for spending on your credit cards? Getting paid hundreds of dollars worth in sign-up bonuses in three months or sooner -- just for tr...
by Christian Hudspeth Tired of dragging credit card debt around with you? Taking 15 minutes to transfer your debt to a credit card with generous balance transfer perks could save you thousands in...
by Christian Hudspeth If you're going to spend money anyway, then why not get paid for it?Whether you're looking for credit cards with up to 6% cash back, double flight miles, or even a free hote...
by Christian HudspethIn times where interest rates are on the rise, you may start hearing financial advisors and bankers sing the praises of an income strategy called "CD laddering" (short for ce...
Those of us familiar with selling property know real estate agents don't come cheap. With real estate agent commission and fees amounting to as much as 6% of the selling price (that's $18...
Beverly Harzog is a nationally recognized credit card expert, author, and consumer advocate. She blogs about credit cards at BeverlyHarzog.com. Being in credit card debt is the pits. I've bee...
If you haven't already felt the pressure to refinance your mortgage, you're probably really feeling it now. Mortgage rates are still hovering near historic lows. But with the economy improving...
If you or someone you know is thinking about getting a home mortgage, you may want to know about the thousands of dollars in hidden charges that some lenders are quietly adding to mortgage loans ...
by Christian Hudspeth Money market accounts (MMAs) and savings accounts make great places to set aside your emergency fund money and earn some interest income at the same time.Simply put, these s...
by Christian Hudspeth It's true that auto loans and home loans offer attractively-low annual percentage rates (APRs), while credit cards offer borrowing power without the risk of ever seeing the ...
by Christian HudspethWant to keep your emergency fund safe while earning interest yields that are three to five times higher than a typical savings account? Putting your money into an FDIC-insure...
Question: Hi there. I need your advice. I'm only 19 and I really need to start investing. Where can I start? -- Tirelo M., Gaborone, Botswana Answer: You've definitely got the right thinkin...