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Profit margin

Profit margin is earnings (or corporate profit) divided by sales (or revenue), expressed as a percentage.

Contents

Expanded Definition

Profit margin usually refers to net margin (that is, how much net income was generated per dollar of sales), but it can also refer to other levels of profit margin, that is operating profit or gross profit.

Industry dependent

For investors, the profit margin of a company must always be looked at in terms of the company's competitors. It does no good to look at Microsoft's (MSFT) 29.3% profit margin and say that is "better" than Safeway's (SWY) 2.1%. The company's operate in different industries and are not comparable. Much better to compare Safeway to Kroger (KR) -- 1.7% --or Costco (COST) -- 1.3% -- or Whole Foods (WFMI) -- 1.9%, all "grocers." That's a better comparison.

A high profit margin compared to its peers implies a successful business well able to outdo its competitors. That can mean key technologies protected by patents or high market share. It can also imply unique raw materials positions that others cannot easily duplicate. These aspects make a business able to defend its profitability from competitors.

A lower profit margin than its competitors suggests a business having trouble differentiating itself or controlling its costs.

Over time

Now profit margins should, ideally, grow over time as the company gets bigger -- spreading its fixed costs over more revenue -- or better manages its costs. To see if this is happening, you should look at profit margin over several years. Looking at the different levels of profit margin (operating, etc.) can give you a sense of where costs are being controlled, too. Is it in materials? Then that should improve gross profit margin. Are salaries to upper management being cut (we can hope!)? Then that should improve operating profit margin.

For cyclical business, such as steel manufacturers or auto makers, profit margins go up and down with the cycle of their business, even becoming negative at the bottom of the cycle. So for these types of businesses, looking at several years worth of numbers is also necessary. Nay, required!


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