In my February 2007 Recap, I disclosed how direct link and post sales boosted my monthly blogging earnings. Direct sales increased my profit margins, the percentage of income I receive from ad sales, and helped to nearly quadruple my normal income from my investing weblog.
Why is profitability important to businesses?
High profitability is a key staple in successful businesses. Simply put, companies with high profitability ratios take in more income per unit/widget sold than businesses with lower profitability ratios. When searching for stocks to buy, I put a lot of emphasis on how profitable the company is because small revenue increases can bolster company earnings by a lot. To show how crucial profitability is in determining which stocks to invest in, observe the profitability ratios of two well known companies: Apple and Microsoft.
Maximize Profit Margins to Increase Your Earnings
Left Column = MSFT; Right Column = AAPL
Fidelity's comparsion chart explains why I hold shares of Microsoft stock over shares of Apple. Some investors will argue that Microsoft's growth has stalled, but what's really shocking is that Microsoft grosses twice as much profit per unit sale than Apple does.
Are you still wondering why Microsoft earned $11.9 billion in earnings last fiscal year? If you are still at doubts, let's take a further look at the stats.
Operating margin equals operating income divided by net sales, including variable costs like labor & wages, third party costs, etc. Microsoft maintains a stronger operating margin because they employ vertical integration across all their businesses. Although Microsoft's company staff is 4 times bigger than Apple's, they save money by designing, manufacturing, and selling their software under the Microsoft label.
Apple spends way too much money to generate earnings.
- In Q1 2007, Apple spent nearly $5 billion to generate $7.1 billion in earnings.
- In Q1 2007, Microsoft spent only $1.6 billion to generate over $10.8 billion in earnings.
If Apple continues to spend at this rate, even the iPhone cannot turn around these paltry profit margins.
Smart management has kept Microsoft's 5 year net profit margin average above 25%. Apple stands at 11%; the industry average is below 9%. When you maintain a strong profitability profile, it becomes a lot easier to generate earnings.
Tweak Profitability Ratios in Your Favor
If you're investing in stocks, take some time to find companies that stay highly profitable. These businesses will continue to make money in most market conditions because they limit costs and maximize profit potential.
If you want to make more money at your job, sit down and calculate how much income you earn every day as an employee. Now, subtract daily costs such as transportation and food to arrive at your daily profit margin ((Income – Expenses) divided by Income) . Once you get that number, figure out ways to increase your profitability.
- Ask for a Raise
- Take your lunch to work
- Carpool with a friend
- Skip that Starbucks latte
- Quit your job and get another job that has a better profit margin
Don't Forget The Rest of the Equation
Profitability is only one part of the equation. Earnings, risk aversion, and valuation are all important aspects of any business model. This does not apply to just investing, in fact, everyone can calculate these numbers on their own. If you're an employee, you make up a percentage of your employer's fixed cost, therefore you can figure out exactly how much your services are worth (hint..it's close to your current salary). I wouldn't advise selling yourself short either. Invest in highly profitable opportunities, and your ROI will be worth the time and effort.
Note: I own shares of Microsoft (MSFT).