Why I Won’t Recommend a Stock with a 99% Operating Margin

November 12, 2025

Any monkey can beat the market…claimed an article Forbes in 2012.

The publisher cited findings from a report by Research Affiliates. The latter randomly selected 100 portfolios with 30 stocks from a universe of 1,000 stocks. The quirky thing here was that the wallets were selected by monkeys.

You read that correctly.

The trial involved replicating 100 monkeys each year throwing darts at the stock pages. They repeated this process every year, from 1964 to 2010, and monitored the results.

Amazingly, on average, 98 out of 100 monkey portfolios beat the 1,000 stock cap weighted stock universe every year.

Why all this monkey stuff?

Well, it started in 1973 when Princeton University professor Burton Malkiel claimed in his best-selling book, A Random Walk Down Wall Street, that…

• A blindfolded monkey throwing darts at the financial pages of a newspaper could select a portfolio that would perform as well as one carefully selected by experts.

Research Affiliates, in turn, claimed that the monkeys actually outperformed ‘experts’ in the stock market.

It’s the kind of story investors love because it makes the stock market sound like a glorified casino where luck, not skill, separates the winners from the rest.

A similar trend appears to have occurred when it comes to investing in new stock listings (IPOs), shares of companies reporting a very high total addressable market, companies declaring monopoly status and companies in new emerging sectors.

For example, in the run-up to an entity’s IPO, profitability should ideally be the most closely watched number. It is the profitability measure that should give investors the confidence to buy the shares at a reasonable valuation in the IPO.

But there’s a specific trend emerging for most new-age companies, with financials showing sudden gains in the most recent quarter before filing.

It has become common for startups to show only a quarter or two of profitability right before the IPO. All thanks to last-minute ‘other income’ and accounting adjustments.

Be it Groww, Lenskart, Urban Company, Pine Labs or any other high-profile IPO in recent months, the story of sudden profitability seems common.

Naturally, the accounting adjustments are within the Indian accounting standards. They are disclosed in IPO documents (DRHP). They are signed by accountants and investment bankers. Therefore, there is no regulatory embargo.

But that doesn’t disguise the fact that such gains are at best unsustainable and at worst illusory. For private investors, the biggest challenge is distinguishing between a real turnaround and a financial facelift.

One-time items, such as asset sales, fair value adjustments or accounting gains, can make companies appear temporarily profitable. Unfortunately, IPO valuations are based on the most recent EPS.

So the IPOs embrace ‘Imaginary Profits Only’.

But let’s not just blame the IPOs. Yes, the gain is temporary. Yes, investors are still eager to pay multiples hundreds of times higher than reported earnings to speculate on stock market gains.

But that is entirely the investor’s decision.

There are also cases of listed shares where the entity claims to have growth prospects that defy logic. They make the practice of studying historical trends look stupid.

For example, IRFC is the main financing arm of Indian Railways. It borrows money from the financial markets to finance the acquisition or creation of assets, which are then leased to the Indian Railways.

Thanks to the government guarantee, the company, a financing entity, does not issue or report non-performing loans.

Compared to any other NBFC, the company has a dedicated team for processing the leases. Moreover, the country pays very low taxes. Understandably, the company achieves almost 99% operating margins.

The optical illusion of the company’s monopolistic nature has seen its shares receive premium valuations since listing.

But what is ignored is that the entity’s accounts receivable days are more than 3,800 days. In other words, if NPAs were recorded or anticipated, the company might struggle to survive.

Then there are entities like LMW (formerly Lakshmi Machine Works) that have cashed in on their near-monopoly status. LMW technically has a monopoly in the production and sale of textile spinning machines, CNC machine tools, heavy castings, etc.

Although the company has invested in capacity expansion, technology upgrades and modernization of production processes to meet customer demands, profits have been scarce over the past decade.

But even the company’s low operating margins and return ratios haven’t kept investors away from the stock.

The ability to bring its precision manufacturing skills to segments like defense has kept the stock’s valuations elevated at double and triple-digit multiples. In fact, the stock is up six times in the last five years.

So it’s not just IPOs that embrace an imagined future profitability. The belief that the ‘monkey’ dart throwing strategy will deliver fantastic results is so deeply ingrained among investors that only a sharp market correction can reveal the real picture.

Until then, warning emptor, buyer beware.

Kind regards,

Tanushree Banerjee
Editor, StockSelect
Equitymaster Research Private Limited (formerly Equitymaster Agora Research Private Limited) (Research Analyst)