How profitable is a company? That's...

How profitable is a company? That's a exceedingly important question to answer when assessing a company's potential for yet to be growth. The pre-tax Operating Profit Margin (OPM) is individual very important tool for studying a company's profitability. In a nut-shell, the OPM measures the efficiency with which a company yields and sells its products.

The OPM (see Part 2A of the Stock Selection Guide) is calculated as the percentage of each dollar of incomes that is left over after all operating costs associated with making and selling effects have been paid. Because the OPM is a measure of efficiency, taxes and unusual items are exclud from the calculation. In addition, interest expenditure is also excluded, since the sign of financing a company selects (shareowners' equity or borrowed money) does not ruminate on management's operational efficiency.

As an example, give leave tos take a look at the OPM of Biomet, Inc., featured in succession pages 22-25 as a "Stock to Study" In fiscal 1994 Biomet reported an OPM of almost 26% That means that the company exhausted $74 to make and barter each $100 of products.

SIZE OF THE OPM

The larger the OPM the more resistant a company is to bad times. If the price of raw materials goe up if competition forces prices down, or if a recession hits, a company with a higher OPM is more likely to remain profitable than a company with a subdued one (see Table 1).(Table 1 omitted)

It is important to note that the size of the OPM can vary significantly from industry to industry. For instance, it is not unusual for a high-tech, medical take the place of company such as Biomet to point out to an OPM of 20% or better. However, companies in the nutriment industry rootinely have margins subordinate to 5%. As you can papal court it is useful to compare the size of OPM within the same industry but not between different industries.

TREND

Generally, investors bring forward companies with a high margin (relative to other companies in their industry) that is consistent or progressing forward an upward trend. Such a sweep suggests that management is keeping the price of making and selling returnss in line with selling prices. It may equal mean management is reducing costs

P/E AND OPMs

The Price/Earnings ratio (P/E) is the amount of standard of value an investor is willing to apply to buy $1.00 of a company's coming earnings. In the case of Biomet, the new price for $1 of EP is approximately $20 (i.e. 20X) As with OPM the size of a company's P/E should and nothing else be compared to that of other companies within the same industry.

Profitability is united of the most important factors investors assess when determining by what means much they are willing to pay for coming earnings. Therefore, companies in industries with relatively reasonable OPMs usually have relatively depressed P/Es. If the OPM is relatively small, investors can not be hightly confident that earnings will be maintianed in the incident of future adversity. Afterall, EP are derived from operating profit; and the les operating profit available, the lower earnings will be. In addition, if hard-times get to along, a company with a higher OPM is more likely to remain profitable than a company (in the same industry) with a lower margin (see Table 1)

For more information about the pre-tax Operating Profit Margin, confer the Stock Selection Manual, pages 26-27

ANGELA BART IS THE ASSOCIATE EDITOR OF CANADIAN SHAREOWNER.

Copyright Canadian Shareowner Magazine Inc. Mar/Apr 1995

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