Profit margins

"Do you think Coca-Cola is worth a penny more than, say, Joe's Cola? I think so — and I've got about 127 years of history to back that up."

Do you think Coca-Cola is worth a penny more than, say, Joe's Cola? I think so — and I've got about 127 years of history to back that up.

Margins tell you how much of every dollar of revenue is left as profit at different levels of the income statement - a company can grow and lose margin at the same time.

Gross margin is revenue minus cost of goods sold, divided by revenue: it measures how profitable the product or service is before overhead. Operating margin also subtracts overhead and selling expenses; net margin subtracts everything, including taxes and interest. Comparing the three levels over time shows whether a company is losing margin to higher overhead, more competition, or both.

A margin number alone says little without a point of comparison: a 10% net margin is excellent in a low-margin sector like big-box retail, but mediocre for a software company, where margins of 25-30% are the norm. Comparing a company's margin with that of its direct competitors, in the same sector, says far more than the number taken on its own.

A margin that stays stable or grows over time, even as raw material or labor costs rise, is often a sign of a real competitive advantage: the company manages to pass higher costs on to its selling price without losing customers. A margin that keeps compressing, even as revenue grows, instead signals that competition is eroding the company's pricing power.