In assessing companies’ financial strength, the capability of generating profits is good. The ability to grow those profits is better. Best of all is the rate of profitability.
How much money a company makes on each dollar of sales is a measure that sums up a lot of things— how well management controls costs, and how well the company serves customers with goods and services, which in turn is a function of how proficiently management is executing the business strategy. Sustained profitability equals good management.
Profitability is expressed in two types of profit margins. Operating profit margin is the percentage of revenue left over after paying for the variable costs of production such as wages and raw materials. Interest payments on debt, taxes and other indirect costs aren’t included. Operating income is divided by revenue to determine the margin.
Net profit margin is broader, accounting for all overhead costs. It is calculated by dividing net income by revenue.
The table below shows the median operating and net profit margins for the Barron’s 400 and the 6,000-stock universe from which MarketGrader selects the index components.
|Median Oper Margin||Median Net Margin|
Some observations about the data: First, the difference in median operating and net margins between the Barron’s 400 and the universe is greatest in the health care sector. This gap suggests that many companies in that industry don’t have a firm handle on the changes that are occurring in health insurance.
Second, the consumer discretionary sector has small differences in margin medians between the Barron’s 400 and the universe. That’s because there is a wide range of margins in this sector due to its great diversity in lines of business, including manufacturers of clothing to snowmobiles, retailers of different kinds, restaurant chains, lodging and media, among others.
Third, the fattest profit margins are in financials. Maybe that explains why there are so many banks.