Two companies with the same revenue can be radically different: one converts its capital into profit efficiently, the other does not. Profitability measures that efficiency.
Margins: how much is left?
- Gross margin: what remains after production costs. Reflects pricing power.
- Operating margin (EBIT): after running costs. The heart of operating profitability.
- Net margin: what is ultimately left for the shareholder.
ROE and ROCE: the return on capital
ROE (return on equity) measures the profit generated for each euro put in by shareholders. ROCE does the same for all capital employed. Sustained above 15–20%, you are often looking at a quality company.
Beware ROE inflated by debt
A high ROE may simply reflect heavy borrowing rather than a better company. That is why ROCE, which takes in the whole capital structure, is a valuable complement.
The link with the moat
High, durable profitability is the signature of a competitive advantage (a moat): without a barrier, competition would eventually erode the margins. Quality shows in the persistence of returns.
À retenir
- ✓Margins tell you how much of each euro of sales becomes profit.
- ✓ROE and ROCE measure capital efficiency; sustained above 15–20% = quality.
- ✓High, persistent profitability betrays a real competitive advantage.