Assumptions Made During Stock Price Valuation
Estimating the value of equity stock of a company is not an easy proposition. This is because while estimating the stock price, all the data required to be used in the formula is not easily available. This is because the data is subjective. It is really the analysts call on what they believe about the […]
Sample Size Neglect
Stock investments are supposed to be made based on rational choices. In this module, we have so far learned that investors are not exactly rational and tend to become emotional a lot of times. However, it is important to note that there are some cases in which investors are pretending to be rational but are […]
Why must corporations be taxed?
We live in a capitalist world today. This is the era of multinational corporations. Today, there are many companies that are more powerful as compared to entire nations. This is the reason that they sometimes lobby hard to avoid taxes. Many times, when these companies are in a dominant position, they even threaten governments that […]
What are Unicorns?
In our day-to-day life, we often use the term unicorn to refer to a mythical horse-like creature. In the year 2013, a venture capital investor named Aileen Lee borrowed the term to describe a particular kind of startup company. The unicorn term was used to describe the startup companies which were thought to be so […]
Why Hedge Funds Fail ?
Hedge funds are considered to be the riskiest of all asset classes. Almost everybody considers hedge funds to be completely speculative in nature. Add to this the fact that Securities and Exchange Commission (SEC) allows only accredited high net worth individuals to invest in such funds and they start to look all the more suspicious. […]
The untrained investor uses profit and profit margin interchangeably. This is not technically correct. The difference may be minor but it is vital. This article will explain about profit margins in detail.
Profit and profitability are two different things. Although they may be closely related, they have a subtle difference. Profit is the absolute number that a company is earning. Profitability on the other hand implies profit margins. Margins are calculated on a per unit basis. Secondly they consider the amount of capital that has been employed to generate the profit. Thus profitability i.e. profit margins are a wider concept.
There are different measures of profitability that a company can choose from. Similarly there are different profit margins that a company can choose from. It is common practice to convert each profit figure into a margin.
Margins need to be compared with industry and relevant competition. A 15% return may be great for a utility company but may suggest serious problems with an information technology firm. Luxury brands such as Armani, Rolls Royce, and Rolex have very high profit margins. This is because the cost that they put in is small and they are reaping the benefits of the brand that they have created. Comparing a Rolls Royce profit margin to a Maruti would not be advisable even though both of them are cars.
Profit margins are very important to understand how diminishing returns work in the context of the firm. Using various profit margins, the firm can look at the profitability figures and find out the level of production where the costs are minimum and profit margins are high. This is the quantity that the company should optimally produce.
The drawback with profit margins is that they do not consider volume. It is for this reason that a separate Cost-Volume-Profit analysis often needs to be done. Usually profit margins and volume are inversely proportional to each other. Higher margins indicate lower volumes and vice versa. There are unusual cases where margins and volumes are both high. However, these are usually examples of monopoly.
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