More Profitable than Microsoft: Three Promising Businesses that are Delivering Better Profit Margins than One of the World's Most Dominant Companies No ordinary company can turn a $10,000 investment into $6 million in just over a decade. But that is exactly what Microsoft stock did between 1986 and 2000. Never in U.S. history has a company  been responsible for creating so much wealth and so many multi-millionaires in such a short period of time. What's even more amazing is the consistency of Microsoft's performance over the years. You didn't have to jump into Microsoft when it first went public in 1987 to make stellar returns. By the end of 1991, Microsoft

In other words, Microsoft was by no means a speculative small-cap play. As you can see in the chart, the stock still returned more than +3,800% between 1992 and 2000, for an annualized return of over +52%.  Perhaps even more amazing than Microsoft's stock performance is its total domination of the desktop software market. Microsoft quite literally went from an insignificant tech startup in the mid-1980s to holding a near monopoly in the global software market by the mid-1990s.  Today, the company's Windows software is

(1.)  Profitability is Key

What exactly sets Microsoft apart from most other publicly-traded stocks? When looked at from a strictly financial standpoint, the answer to that question is surprisingly simple. The most striking aspect of the software giant is its high and consistent profitability.

But when we mention profitability, we are not talking about how many dollars Microsoft earns in a given year or how fast its earnings are growing. Rather, we're referring to the company's profit margins.

Although there are many different ways to measure profitability, they all address basically the same issue: out of every dollar of sales, how much does a company keep as profit? By looking at margins instead of total dollar profits, we're better able to compare companies of different sizes.

Here are some of the profitability metrics that we watch closest:

Net Profit Margin -- This most basic measure of profitability is calculated by dividing a company's total net profit by its total revenues -- basically, how much of every dollar taken in becomes profit. The number is then expressed in percentage terms.

Operating Margin -- Operating margins are calculated almost exactly like net profit margins; the only difference is that operating profits are substituted for net profits. The advantage of this measure is that net profit margins are often skewed by one-time events such as the sale of real estate or gains on investments that aren't part of a company's normal business. However, by looking at operating margins, investors reduce this problem.

In the chart we've highlighted Microsoft's operating margins since 1987. Since that time, Microsoft has delivered average operating margins of more than +35%. Even better, the chart shows just how consistently profitable Microsoft has been over the years. In only one year did the firm's operating margin figure drop below +30%, and in the boom years for technology in the 1990s, margins climbed as high as +50%. Of course, these figures mean little in isolation. In order to really get a sense for just how profitable Microsoft is, this chart also includes the operating margins a couple of other

(2.)  The Many Advantages of Profitability

Why exactly has Microsoft's profitability been such a major advantage over the past two decades? The most obvious answer is that more profitable companies generate higher earnings and profits for their shareholders. This cash can then be used to finance acquisitions or expansion into new markets. Or, when growth opportunities are exhausted, companies with high profitability can afford to perform shareholder-friendly maneuvers like paying out high dividends or buying back stock.

But what's even more important about keeping an eye on profitability metrics is that high margins are symptomatic of companies with strong competitive advantages. In other words, companies with consistently high margins tend to sport high market share and attractive business models. These are just the sort of companies that could become the next big winner -- the next Microsoft.

The reason Microsoft's dominance has translated into profitability is simple. When several rivals battle it out in a particular market, they usually attempt to compete with one another on price. In addition, companies in competitive markets often have to spend heavily on advertising and new product design in an effort to differentiate their product from the competition. Both moves have the potential to reduce margins. The falling prices obviously cut earnings and margins, while rising marketing costs can eat into profits.

Some of the weakest profit margins can be found by looking at commodity-based companies. These firms sell products -- such as steel, gold, or wheat -- that can't be differentiated from competitors' products. While temporary shortages can certainly cause a spike in prices and industry profit margins, these spikes tend to be short-lived. Once the shortage is past, competitors will compete viciously on price, driving margins lower. That's why most commodity companies operate on razor-thin margins.

By contrast, Microsoft operates in a market with few real competitors. The benefit of this dominance is that Microsoft doesn't have to compete on price with another major company. Over the years the prices of most technology products, such as personal computers, memory, and even mobile phones, have dropped drastically. PC prices, for instance, have fallen by as much as -90% since the 1980s. But this isn't the case for Microsoft. The company has been able to maintain its prices over the years, helping it to sustain margins even during the recession and tech crash of 2001-02.

Here are some of the main factors that contribute to Microsoft's competitive advantages and thus, high profitability:

Brand Name -- Microsoft was one of the first major tech brands. The firm's name is well-recognized and largely trusted by consumers. The company has even branched out into non-traditional products, such as its Xbox and Xbox 360 game consoles, as well as hardware like wireless networking equipment. The benefit of the brand is that it gives Microsoft instant recognition when the company enters a new market. Moreover, the company can charge more for its products than a generic competitor because consumers trust the brand.

Switching Costs -- Millions of consumers worldwide have learned to use a computer with a Windows operating system. And most have been using Microsoft Word, Excel, and Internet Explorer software for over a decade; it takes time and effort to learn how to use a totally new program. Moreover, most corporations worldwide have Windows and Microsoft Office installed on their corporate systems. As a result, switching software would be an extremely expensive proposition, both in terms of up-front costs and in terms of the new training that would be required.

The various components of Microsoft's desktop software (word processing, Internet browsing, and e-mail, for example) are designed to be inter-compatible. In other words, it's easy to cut and paste text, graphics, and tables from Excel to Word and vice-versa. This makes it advantageous to use many of Microsoft's products. All of these factors make it difficult and time-consuming for consumers to use competing products, thereby enhancing Microsoft's dominance.

The "Network Effect" -- Nowadays, a tremendous amount of information travels throughout the world via e-mail and the Internet. However, because more than 90% of global consumers use Microsoft's Word and Excel programs, these have become the de-facto standards. It can be tough to convert files from Word to another word-processing program. Therefore, most users simply use Word, Excel, and other Microsoft products in order to avoid this problem. The beauty of this network effect is that as Microsoft's base of users becomes larger, this advantage continues to grow.

With these points in mind, we spent countless hours scouring our database of thousands of companies in search of stocks that exhibit higher or similar profit margins compared to Microsoft, based on many of the various measures outlined above. We further trolled through this list to identify a handful of firms that have cultivated dominance in a particular market niche and have developed competitive advantages similar to those enjoyed by Microsoft. In the table that follows, we offer a long list of stocks that fit the bill. And in the text that follows, we'll highlight a few of our favorite highly profitable stocks.

(3.)  Stocks that are More Profitable than Microsoft

With these points in mind, we spent countless hours scouring our database of thousands of companies in search of stocks that exhibit higher or similar profit margins compared to Microsoft, based on many of the various measures outlined above. We further trolled through this list to identify a handful of firms that have cultivated dominance in a particular market niche and have developed competitive advantages similar to those enjoyed by Microsoft. In the table that follows, we offer a long list of stocks that fit the bill. And in the text that follows, we'll highlight a few of our favorite highly profitable stocks. . .