Download the Schwab app from iTunes®Get the AppClose

Profit Margin - A Fundamental Growth Analytic

Profit Margin: A Fundamental Growth Analytic

The term “profit margin” refers to the percent of profit a company makes from each dollar of revenue it generates. In other words, profit margin measures how much out of every dollar of sales a company actually keeps in earnings. The calculation is fairly straightforward. A company’s profit is simply total sales minus total operating expenses. A company that generates $100 million in sales and keeps $20 million in profits is said to enjoy a profit margin of 20% ($20 million of profit / $100 million of sales).

What traders look for

The profit margin provides an indication of how efficiently a company runs its operations. Clearly, the higher the profit margin, the better. In essence, profit margin is greatest for companies that maximize their sales revenues and minimize their operating expenses.

This value is especially useful when comparing different companies in the same industry group. For example, if one auto manufacturer, has a profit margin of 2% and another a profit margin of 5%, this provides a clear clue that the latter is running its operations more efficiently and is squeezing more profit out of each dollar of revenue.

Another useful way to analyze profit margin is to compare the current annual profit margin for a given company to its own average annual profit margin over the past 5 to 10 years to see if the company is able to maintain a consistent rate of profit margin.

What traders look out for

One way that a company can maximize its profit margin is to reduce its operating expenses. That being said, there can be times when a company’s management will get so carried away with cutting costs that they will actually hurt the company’s ability to function efficiently. For example, this can happen by cutting too many workers which can affect the company’s ability to produce enough product in a timely manner, or by reducing inventory to a level that fails to meet current demand, which can result in lost sales.

It is possible for a company to sow the seeds of its own future troubles by attempting to maximize its profit margin via an aggressive reduction in operating costs.  


It should be noted that one company with a higher profit margin may not necessarily be a better investment than another company with a lower profit margin. Many other factors such as sales and earnings growth, as well as value factors such as price/earnings and price/book value ratios may result in one stock with a higher profit margin soaring to an overvalued price, while the stock of a company with a lower profit margin might be undervalued.

In the long run, companies that operate most efficiently have the greater potential to grow their earnings at a higher rate. Profit margin represents an excellent gauge of company efficiency.

Free Cash Flow: A Fundamental Growth Analytic
Sales Growth: A Fundamental Growth Analytic
Sales Growth - A Fundamental Growth Analytic

Schwab has tools to help you mentally prepare for trading

Learn more >

Talk trading with a Schwab specialist anytime.
Call 888-245-6864
M-F, 8:30am - 9:00pm EST

Get 500 Commission-Free Online Equity and Options Trades for Two Years

Learn More >

Schwab does not recommend the use of technical analysis as a sole means of investment research.
The information here is for general informational purposes only and should not be considered an individualized recommendation or endorsement of any particular security, chart pattern or investment strategy.
Past performance is no guarantee of future results.
©2014 Charles Schwab & Co., Inc. (Member SIPC) All rights reserved. 


Thumbs up / down votes are submitted voluntarily by readers and are not meant to suggest the future performance or suitability of any account type, product or service for any particular reader and may not be representative of the experience of other readers. When displayed, thumbs up / down vote counts represent whether people found the content helpful or not helpful and are not intended as a testimonial. Any written feedback or comments collected on this page will not be published. Charles Schwab & Co., Inc. may in its sole discretion re-set the vote count to zero, remove votes appearing to be generated by robots or scripts, or remove the modules used to collect feedback and votes.