Understanding Profitability Ratios And What They Can Tell Investors
Profitability ratios are among the most commonly cited tools in fundamental analysis. But beyond the numbers, these ratios tell powerful stories about a company's strategy, efficiency, scalability, and ability to compete. In this guide, we’ll unpack the most important profitability ratios, how to interpret them in different market cycles, and what to watch out for when comparing companies across sectors.
What Are Profitability Ratios?
Profitability ratios measure a company’s ability to generate income relative to revenue, assets, equity, or capital employed. They offer insights into how well a company manages its costs and turns resources into profits.
Core Profitability Ratios Explained
1. Gross Profit Margin
Formula: Gross Profit / Revenue Tells you: How efficiently a company produces its goods/services before overhead.
High Margin: Strong pricing power or efficient production
Low Margin: Price competition, high input costs, or poor supply chain management
Example: Apple may report >40% gross margin, while a grocery retailer like Kroger may operate at
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