Online Investing Hacks

Calculate Profitability Ratios

Calculate and evaluate a company’s profitability to determine its chances of future success.

One of the cornerstones of successful long-term investing is identifying stocks whose profits are growing steadily. The idea behind this approach is that a company that consistently grows its earnings will eventually see its share price grow as well. Although companies can increase their earnings by selling more goods or services, they also must be mindful of how much of each dollar of sales represents profits on their books if they want to make as much money as possible (which is any company’s goal, after all). There are several ways to assess a company’s profitability, and each way reveals how well the company is run and whether the company is well-positioned for the future.

Key Profit Margins

Like canaries in a coal mine, profit margins serve as an early warning device. If profit margins begin to fall, earnings might begin to decrease, which often leads to drops in stock price. By watching for downward trends in profit margins, you can sell a company before its slipping performance hurts your portfolio. The key profitability ratios to examine are gross margin, operating profit margin, net profit margin, and pre-tax profit margin.

Gross margin

Start your analysis of a company’s profitability by examining its gross margin. This figure reveals how inexpensively a company can manufacture or acquire the goods it sells to customers. To calculate a company’s ...