Profit Margin
This column covers fundamental analysis, which involves examining a company’s financial statements and evaluating its operations. The analysis concentrates only on variables directly related to the company itself, rather than the stock’s price movement or the overall state of the market.
Profit Margin
Anal
ysis
A company’s stock price, in large part, is driven by the company’s ability to generate earnings. Therefore, it is useful for investors to analyze the profitability of a company before investing in it. One way to do this is by calculating and tracking various profit margins, which reflect how efficiently a company uses its resources.
Profit margins are expressed as a ratio, specifically “earnings” as a percentage of sales. By expressing margins as a percentage, we are able to compare the profitability of different companies more easily. Margins allow investors to judge, over time, management’s ability to manage costs and expenses and to generate profits. Management’s success or failure determines the company’s profitability.
Strong sales growth is meaningless if management allows costs and expenses to grow disproportionately.
In this Fundamental Focus, we highlight three key profit margin ratios—gross profit margin, operating profit margin and net profit margin.
Gross Profit Margin
The gross profit margin (gross margin) measures the profit a company
makes from its cost of goods sold
(cost of sales). Cost of sales represents expense related to labor, raw materials and manufacturing overhead used in the production process.
This ratio measures how efficiently management uses labor and raw materials in the production process, and it is calculated as follows:
Gross profit margin = (sales – cost of goods sold) ÷ sales
A company uses its gross income to fund such company activities as research and development and marketing, which are important for generating future sales. A prolonged decline in the gross profit margin is a red flag
Profit Margin
Anal
ysis
A company’s stock price, in large part, is driven by the company’s ability to generate earnings. Therefore, it is useful for investors to analyze the profitability of a company before investing in it. One way to do this is by calculating and tracking various profit margins, which reflect how efficiently a company uses its resources.
Profit margins are expressed as a ratio, specifically “earnings” as a percentage of sales. By expressing margins as a percentage, we are able to compare the profitability of different companies more easily. Margins allow investors to judge, over time, management’s ability to manage costs and expenses and to generate profits. Management’s success or failure determines the company’s profitability.
Strong sales growth is meaningless if management allows costs and expenses to grow disproportionately.
In this Fundamental Focus, we highlight three key profit margin ratios—gross profit margin, operating profit margin and net profit margin.
Gross Profit Margin
The gross profit margin (gross margin) measures the profit a company
makes from its cost of goods sold
(cost of sales). Cost of sales represents expense related to labor, raw materials and manufacturing overhead used in the production process.
This ratio measures how efficiently management uses labor and raw materials in the production process, and it is calculated as follows:
Gross profit margin = (sales – cost of goods sold) ÷ sales
A company uses its gross income to fund such company activities as research and development and marketing, which are important for generating future sales. A prolonged decline in the gross profit margin is a red flag