Impact Of Gross Profit Margin On Stock Prices Decoded
Date: 14-03-2017 Views: 1036
What is gross profit margin of a company and how does it impact stock prices? Gross profit margin decoded for the stocks investor.
Edited transcripts UDAYAN RAY: Welcome to Fundoo Money, your 24X7 buddy on all matters related to personal finance! In this particular web series, we are dealing with all the major things that an investor needs to take into account while investing in stocks.
Now, in this particular segment, we are going to be looking at a particular ratio. Yeah, that’s right! The word is ratio, financial ratio, which actually comes from one of the financial statements, in trying to figure out the health or the investability, should I say, investment worthiness of a particular stock. That’s coming up shortly.
Gross profit margin, now what on earth is that? Now that is something that you keep hearing in all stock market discourse. A company’s result is out, the stock has gone up or gone down, and people talk about gross profit margin. What on earth is a gross profit margin? How should a person an investor who has invested in a stock be bothered about it? How should he or she be looking at it?
To help us understand that and give us a very simple explanation, we have with us one and only Mohit Satyanand, a stock market expert. Hi Mohit! MOHIT SATYANAND: Hi Udayan!
UDAYAN RAY: Mohit, gross profit margin. Things can’t get more complex than that.
MOHIT SATYANAND: No, no, it’s very simple.
UDAYAN RAY: What is it?
MOHIT SATYANAND: I buy stocks because a company makes profits. I wouldn’t buy stocks if a company was making a loss right? So the gross profit margin tells me very simply, how successful is a company in making a profit? Right? Would you rather own stocks of a company which makes Rs. 2 for every Rs 100 that they charge a consumer? Or, a company which makes Rs. 80?
So it’s actually very simple. I buy stocks because I want a share of the profits of the company. If a company makes more profits I am more interested in buying stocks of that company. The gross profit margin is telling me that for every Rs. 100 of goods that a company sells, what is the gross profit that it makes? That is before charging all the other expenses that a company incurs. So, the first way of looking at it and the most important in my point of view is what I call pricing power. Do consumers value the product of a company substantially enough to allow the company to make a gross profit margin?
If the profit margin is growing sequentially over time over a 5, 7, 10, 15 year period, that to my mind is the clearest signal that the company is in a strong place, the consumers like its product. It’s (the company) is able to create more elbow room with respect to its other competitors in the space and also from an operational or financial point of view, it means that there is more money available for the company to grow to pay all its financial charges.
So, I look at gross profit margin very keenly both from a static point of view which is how does it compare to profit margins of other players in the industry, and from a dynamic or time sequence point of view— how is it changed over time. If the company’s gross profit margins are declining, that means one of two things. Either that it’s losing pricing power with respect to the consumer or its competitors or that that particular market is now not a dynamic expanding market. So, to me this is critical.
UDAYAN RAY:That’s awesome. And one little ratio, I mean one little indicator indicating so much.
