Margins
The same revenue can produce wildly different profits. Margins are how you see that, and how you compare companies of different sizes.
A margin is a profit line divided by revenue. That single operation turns absolute numbers into a rate, which makes two businesses of wildly different sizes comparable.
The three that matter
- Gross margin. Gross profit over revenue. What the product earns before the cost of running the company.
- Operating margin. Operating income over revenue. What the business earns from operating, before financing and tax.
- Net margin. Net income over revenue. What is left at the very bottom.
What each one is telling you
Gross margin is mostly about pricing power and production cost. A company that can charge far more than a product costs to make has something its competitors do not — a brand, a patent, a network, a cost advantage.
Operating margin adds the question of discipline: given that gross profit, how much is consumed by running the place? Two companies with identical gross margins and very different operating margins are spending differently.
A 20% margin means little without context — grocers and software companies live in different worlds. A margin that has moved from 20% to 24% over three years, or from 20% to 16%, means a great deal regardless of industry.
The comparison trap
Margins are only comparable within an industry, and sometimes not even then. A business that manufactures will carry costs a business that licenses does not. Comparing their net margins and concluding one is better run is a category error.