The Importance of Net Profit Margin (includes calculator)

By Stock Research Pro • December 10th, 2008

The net profit margin provides an indication of how well a company is controlling its costs. A high net profit margin demonstrates effectiveness at converting sales into actual profit. The measure is very useful when comparing several companies from within the same industry. Higher net margins can provide a company a significant competitive edge as it looks to improve and expand its operations. In trying economic times, a company with a low measure might have to take on more debt to pay its costs.

How to Calculate Net Profit Margin

The net profit margin is calculated by dividing earnings (profits) by sales, over the same time period and is displayed as a percentage. For example, a 10% profit margin means the company has a net income of $0.10 for every dollar of sales it earns. By comparing the gross and net profit margins, an investor can gain a sense of the company’s non-direct costs, such as administration and marketing costs. The average net profit margin for the S&P 500 is currently about 8.5%.

To gather the data you will need, go to Yahoo! Finance. Enter the stock symbol in the Get Quotes box. On the lower left-hand side, click on the Income Statement.

A Measure of Efficiency

If company management is demonstrating increasing profit margins it is doing so by controlling costs. As most stock investors know, looking at earnings alone doesn’t provide the entire financial picture. The net profit margin offers insight into company efficiency, providing a measure of how much money a company squeezes from its total sales.

While increased earnings are good, if the company also has increasing expenses it will lead to a lower profit margin- an indication that these costs need to be reigned in. The problem could result from rising inefficiencies or increased taxes. Both call for concern from investors.

A Potential Opportunity for Value Investors

Value investors looking for underachieving companies that could turn around might consider a company that is demonstrating lower profit margins than its competitors. If the company appears to be solid in all other aspects, management of the company could find a way to lower costs to the benefit of its investors.

More about the importance of net profit margin


The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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