Margins and pricing power

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Key idea: Steady or rising margins suggest a company can raise prices without losing customers. Falling margins are often the first sign of trouble.

Margins show how much of each dollar of sales the company keeps. Gross margin is what is left after the direct cost of making the product. Operating margin is what is left after running the whole business. Net margin is what is left after everything, including interest and tax.

Levels differ hugely by industry. Software firms often keep 70-80% gross margins; supermarkets often under 30%. Compare a company with its peers and with its own past, not across industries.

The trend matters more than the level. When costs rise and a company's margins hold steady, its customers accepted higher prices, which is pricing power. When margins slide year after year, competitors may be forcing prices down or costs may be getting away from management.

Margins are worth checking on any stock page before trusting a valuation that assumes they hold.

Quick check

Revenue is $500 million and operating profit is $75 million. What is the operating margin?

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