Equity X Leverage profit margin
Net income expressed as a percentage of sales revenue total asset turnover
Sales revenue divided by the book value of total assets
Profit margin is accounting net income expressed as a percentage of sales revenue and shows the amount of profit earned per dollar of sales. When profit margins are high, robust demand or stringent cost controls, or both, allow the firm to earn a significant profit contribution. Holding capital requirements constant, profit margin is a useful indicator of managerial efficiency in responding to rapidly growing demand and/or effective measures of cost containment. Table 10.2 shows the outstanding profit margins reported by smokeless tobacco producer UST, Inc.; diversified financial services provider Stilwell Financial, Inc., growth stock manager of the Janus Group of mutual funds; and Internet portal Yahoo! However, rich profit margins do not necessarily guarantee a high rate of return on stockholders' equity. Despite high profit margins, firms in mining, construction, heavy equipment manufacturing, cable TV, and motion picture production often earn only modest rates of return because significant capital expenditures are required before meaningful sales revenues can be generated. Thus, it is vitally important to consider the magnitude of capital requirements when interpreting the size of profit margins for a firm or an industry.
Total asset turnover is sales revenue divided by the book value of total assets. When total asset turnover is high, the firm makes its investments work hard in the sense of generating a large amount of sales volume. A broad range of business and consumer service business enjoys high rates of total asset turnover that allow efficient firms to earn attractive rates of return on stockholders' equity despite modest profit margins. For example, consider environmental services juggernaut Waste Management, Inc. Despite modest profit margins and a conservative financial structure, Waste Management reports a sterling ROE by virtue of the
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