Stocks With a Competitive Edge
Earnings are dependent on the ability of a company to convert sales into profits. Converting a large and growing proportion of sales into earnings often points to firms that have a competitive advantage, due to brand-name loyalty, a limited niche, or even patent protection. The First Cut this issue screens for companies turning a larger percentage of sales into gross profits, operating profits and net profits.
Gross profit margin is calculated by dividing gross income (sales less the cost of goods sold) by sales. It reflects the firm’s basic pricing decisions and its material costs.
Operating profit margin is calculated by dividing operating income by sales. Operating income represents income generated after all costs except interest, taxes, and non-operating items. The operating margin reflects the relationship between sales and management-controlled costs (the cost of goods sold, as well as operating costs including selling, administrative and general expenses; research and development expenses; and depreciation). It does not consider how the firm is financed or non-business activities. Net profit margin is calculated by dividing net income by sales. It indicates how well management has been able to turn sales into earnings available for shareholders.
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