Saturday, October 11, 2008

Profit Margins

We often talk about profit margins on this site. Analyzing the profit margins of a company can help you determine its profitability relative to its competitors. For example, if two competitors have equal net incomes but one has twice the profit margin of the other, then over time we may see the more efficient company steal market share and grow at a faster rate. (This can happen for several reasons, one being that it can simply lower its prices until its competitor is no longer profitable, thus driving it out of markets.)

One type of profit margin is a company's gross profit margin, which is its gross profit divided by its revenues. It gives a pretty good indication of a company's pricing power versus its product costs. Here we saw that Coke has a gross profit margin of 64% , indicating people are willing to pay quite a bit more for Coke's products than it costs Coke to produce them.

For comparison purposes, here are the gross profit margins for several industries in 2005:

A company's net profit margin is its net income divided by its revenue. Profit margins for 2005 for a few industries are depicted below:

Note that profit margins are not the be-all end-all when it comes to profitability as they don't consider asset utilization. A company able to generate revenue and income on fewer assets is preferable to one that constantly needs capital infusions to grow.

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