Net Profit Margin

Measures how much net profit the company earns for each $1 of revenue.

Revenue is the amount of profitthe company generates before taxes and all other costs. For example, when you buy a cup of coffee it will cost you 3. The company does not earn 3 in profit but also has to pay various costs and taxes to create that cup of coffee. Let's assume the cost of creating a cup of coffee is 1.5.

The 3 you pay for a cup of coffee is called revenue.
The 1.5 that’s left over when all costs to create that cup of coffee (including taxes) are deduced from the revenue is called net profit.

The net profit margin looks at how much net profit the company earns for each 1 in revenue.

How to use net profit margin

Higher profit margin is better (more profit).
Above 10% is considered healthy but always compare the companyto the industry mean.
Can be used to compare companies within the industry.

You typically want a high profit margin. This means that for each 1 in sales,the company makes more profit. This shows the investor how efficiently the company is operating in general and compared to other companies in the same industry. operates in the industry.

Why do investors use net profit margin in their analysis

It helps investors to determine the efficiency of the company. If profit margins remain low (compared to the industry mean) and there are no improvements to make in production costs or other areas that might be a warning sign. If profit margins are high that means the company has low overhead costs and is efficiently using its resources to generate profit.

The three steps every investor should look at:

What is the current net profit margin?
How does it compare to the industry?
What is the trend?

Things to be aware of

Only compare the company with other companies in the same industry.
Net profit margin should rise over the years.
Can be influenced when the company sells assets (profit will increase while costs remain the same).
It won’t show what part of the company is doing great or needs improvement (it only looks at total revenue and total net income).

How to calculate net profit margin

Net profit margin = net income / total revenue * 100%

Higher is better

The higher the net profit margin, the more efficient the company is generating income. This helps investors to determine how the company is managing money. The net profit margin is an important indicator when diving into the financial health of a company. Overall, you want to see the net profit margin rising over the years. That means the company improved their production and made it more efficient (if possible).

You can use the net profit margin to compare companies within the same industry. If there are two companies where one is much bigger but the smaller one has a higher net profit margin, that means the smaller company is more efficiently using operational costs.

Important: Profit margins can be very different between industries. Companies with assembly lines or transports are much more prone to see shifting in prices for fuel, ingredients and maintenance compared to companies that only provide services. You should never compare net profit margin between different industries.