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Type of Securities Investment Strategies Fundamental Analysis Technical Analysis
Introduction to Fundamental Analysis Income Statement Analysis Balance Sheet Analysis Cash Flow Analysis Shareholders' Equity Analysis Ratios and Definitions


Income Statement Analysis

 - Great companies and good
    EPS growth do not guarantee
    stock market profits

 - The P/E ratio can create
    buying opportunities


 - Mishaps can create steals

 - Unusual charges reduce the
    value of your stock

 - ROE is the single best tool
    for investors

 - ROA is another valuable tool

 - Investors pay for high profit
    margins

 - Lenders can eat up all the
    profits

 - Depreciation creates
    deferred taxes, which have
    equity-like qualities


 - EPS is a complicated
    calculation

 

 


Investors pay for high profit margins

Gross Profit (“GP”) Margins – GP margins determine the core profitability of the company’s products. It is calculated by dividing gross profit by sales and is expressed as a percentage.

Gross profit is a product’s selling price less the product’s direct cost of sales. It excludes selling, general and administration expenses. Gross profit margins are very informative when comparing similar companies. One can evaluate a company’s pricing and productivity efficiencies by analyzing gross profit margins. The P&L effects of outsourcing production are reflected here.  I find it useful to think in terms of one unit. What is the product’s selling price?  How much does the product cost? The difference represents the company’s profits prior to operating expenses, interest, and taxes. It is also useful for investors to review prior years’ trends, to compare with future earnings projections.

Operating Profit Margin

Operating profit margins depict how profitable the company’s normal operations are. They are calculated by dividing operating profit by sales, and are expressed as a percentage.

Operating profit as an absolute number is also referred to as EBIT, earnings before interest and taxes. EBIT is widely used by bankers to determine the company’s leverage capacity and interest coverage.

When reviewing earnings estimates, understand the operating profit margins, that are being used in the calculations. Theoretically, margins will increase if a company increases its sales while keeping some of the infrastructure cost fixed. Additionally, operating profit margins can improve by increasing selling prices or by decreasing costs.

Investors, however, should be especially critical of long-term, back-ended projections, that show sales growth combined with big operating profit margin improvements in the future. With the average job lasting only a few years, long-term projections should be viewed skeptically. 

The higher the margins, the greater the earnings available to the shareholders, and therefore, the higher the value of the business.

 

 

 

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