<math>Net\ Margin=Net\ Profit / Revenue</math>
Net margin is expressed as a percent of revenue and is the amount of profit you have for each $1 in sales after deducting all expenses.
For instance, if a company has $1.5 million in net income on sales of $25 million, then the net margin would be $1.5 / $25 = 6%. However, if a different company managed to earn that much on only $12 million in sales, then its net margin would be 12.5%. Woo hoo! This is obviously better for the company and its investors, so companies with higher net margins are probably better.
However, as an investor looking at the two companies, you should pay attention to whether or not the two are operating in the same or different industries because each industry has its own ranges of "normal" net margins. Software sales, such as Microsoft, doesn't require a lot of inventory or expensive land and buildings, so net margins at a company like Microsoft could be expected to be higher than a grocery store.
On the other hand, if the two companies above happen to be in the same industry, then one or the other is in trouble. Your first guess might be that the first one, earning 6%, is in trouble. How come its expenses are so high so as to suck off so much income? At 12.5% like the other one, it should be making $3.12 million, not $1.5 million. But, it could be the "normal" one and there could be something funny going at at the second company. Is it misclassifying expenses such as capitalizing instead of expensing certain things? Is there a bunch of non-operating income? What other games might it be playing with its income statement to make the net margin look so good?
Investors need to be aware of both overly-low and overly-high net margins when comparing companies within the same industry and should not compare net margins across industries, using one as a benchmark for another.
Recent Mentions on Fool.com
- Should Investors Steer Clear of Arista Networks?
- Cliffs Natural Resources in 2015: Why It's Fallen 68%
- This Just In: Upgrades and Downgrades
- Better Buy: Vipshop Holdings Ltd. or E-Commerce China Dangdang Inc?
- George Soros' Fund Dumped These 2 Stocks: Should You?
- 3 Companies That Could Become Tax Inversion Targets