|By Nathan Young|
June 5, 2017
Profit margin is key when evaluating a business and is calculated by net income divided by revenue. Expressed in a percentage, this measures how much money the company makes for every dollar of revenue earned.
For example, if a company has a 10% profit margin, they are earning $0.10 for every $1.00 of revenue. So as easy as it seems, the larger that number the more money the company is earning per dollar of revenue. Typically you want to see this number be higher compared to competition, because they are earning money more efficiently.
If you have been studying the stock market and businesses, then you will know that cash is king and the life blood of an organization. When looking to invest in a business, profit margin is something you want to keep your eye on because this is how the company makes money and continues to grow. Obviously you have to look at other aspects of the business, but profit margin needs to be healthy. Investing in a business that sold computers and sold thousands, but only had one percent profit margin, that may not be a good investment because the margin is low but if the cost of a part of that product increases, they may lose the profit margin and it becomes negative.
When starting a business, profit margin may be low because you are just trying to sell and get a brand built, but that cannot be sustained into the future. If there are small profit margins, take a step back and ask yourself why that is and if the company is doing anything about it, because that is a risk in your portfolio.
There are a multitude of different margins you need to look at but this is certainly of the more important ones. However, you have to take it into account with the others because that will give you a well rounded opinion. Reach out to an investing community because they can help you in your research and give you ideas on how they implement this data point. Also, feel free to reach out to your investing professional as they can help to guide you in the right direction. Profit margin is key to a successful business and without a healthy margin, future growth could be limited.