Why Use Profit-Margin Ratios?
The bottom line is the first thing many investors look at to gauge a company’s profitability. It’s awfully tempting to rely on net earnings alone to gauge profitability, but it doesn’t always provide a clear picture of the company, and using it as the sole measure of profitability can have big repercussions. Profit-margin ratios, on the other hand, can give investors deeper insight into management efficiency. But instead of measuring how much managers earn from assets, equity or invested capital, these ratios measure how much money a company squeezes from its total revenue or total sales. Margins, quite simply, are earnings expressed as a ratio – a percentage of sales. A percentage allows investors to compare the profitability of different companies, while net earnings – an absolute number – cannot. Consider this example. In its final quarter of 2003, personal computer-maker Dell had an annual net income of $749 million on sales of about $11.5 billion. Its major competitor, HP, earned
