When a company releases its earnings results for a quarter, the focus is often on its top and bottom lines. But one number that investors shouldn't overlook is gross margin. A strong gross margin can ensure that a company's profitability improves over time as its revenue increases. And for businesses that aren't yet profitable, it's a good indicator that at least they may eventually get out of the red.
Two companies that have strong gross margins of 70% or better include Align Technology (ALGN 0.56%) and Etsy (ETSY 1.32%). Add to that some promising growth prospects, and these are two stocks that investors may want to consider for their portfolios.
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1. Align Technology
Medical device company Align Technology is known for its popular Invisalign dental braces. Earlier this year, the company hit a milestone with its 10 millionth Invisalign patient. The products are convenient for patients since, unlike regular braces, they are barely visible. The bulk of the company's revenue -- roughly 83% -- comes from its clear aligners with the remaining portion belonging to its software and imaging systems that scan teeth.
Over the past four quarters, the company has posted a profit of $698 million on revenue of $3.5 billion, giving it a net margin of 20%. A key reason it has been able to do that is due to the low cost of goods sold -- averaging less than 26% of revenue -- leaving the remaining 74% of the top line to help cover overhead and other operating costs.
For fiscal 2021, Align Technology projects that its net revenue could come in at just under $4 billion, which would amount to a year-over-year increase of 60%. The company projects an operating margin of between 24% and 25%, so its operating profit could top $1 billion -- well over double what it reported in 2020. And these numbers may only get bigger as Invisalign grows in popularity.
If you're a long-term investor, Align Technology can make for a solid growth stock to buy; the global invisible orthodontics market is set to rise at a compound annual growth rate of more than 15% through 2026.
2. Etsy
Investors may be tempted to dismiss online marketplace Etsy as nothing but a stay-at-home stock that won't do as well once the pandemic is over. However, amid "The Great Resignation" and the desire to work from home, Etsy could help fill a gap in income -- or potentially even become a significant source of it. Its marketplace is more of a home for unique and handcrafted items -- unlike rival eBay, which is known for a wider range of products with the focus often on cheap over quality.
And even though the economy is slowly returning back to normal, that doesn't mean consumers are ditching Etsy. For the period ending June 30, the company reported more than $3 billion in gross merchandise sales, or a year-over-year increase of 13%. That's across all its marketplaces, which include both Etsy.com and Reverb.com, where consumers buy and sell musical instruments and gear.
That resulted in revenue of $528.9 million, or a 23% improvement from the same period last year. Overall, net income of $98.3 million rose by just under 2%. Notably, the number of active sellers -- 5.2 million -- grew by 67% while active buyers increased by 50% to 90.5 million.
As it isn't seeing a significant slowdown, Etsy anticipates that for the next quarter gross merchandise sales will continue to grow about 13%. The company isn't providing full-year guidance due to the uncertainty of the pandemic, but Etsy's gross margins have been around 74% over the past four quarters, making it easy for it to consistently post a profit during that time.
With a resurgence in COVID-19 cases, it's perhaps unsurprising that shares of Etsy have risen 29% in the past three months vs. 5% for the S&P 500. But regardless of whether you view this as a pandemic stock or not, Etsy is showing that it can do well even though there aren't lockdowns in place. For many people, it could end up being part of their new normal. And with strong margins, there's lots of room for its profits to continue increasing over the years.
