A company with higher net margins than its peers often shows strong management and competitive advantages, which can build wealth for shareholders over time.
In this guide, we’ll cover everything you need to know about net margins, including how to calculate them, what factors influence them, and what a good net margin is for different industries.
What Are Net Margins?
The net margin is a profitability ratio that shows the percentage of revenue a company retains as profit after accounting for all the business’s expenses. It directly measures how much of every dollar in sales is converted to profit.
The net margin comes directly after the operating margin on the Income Statement, which measures a company’s profit after operating costs. Net margin includes the cost of expenses like taxes and interest payments, which are not included in the operating margin.
How to Calculate Net Margins
Calculating net margins involves two main components:
- Net Income: A company’s bottom-line profit after deducting all expenses from revenue.
- Revenue: The total sales generated by the business.
The formula for a company’s net margin is:
Net Margin = (Net Income ÷ Revenue) × 100
Example: Netflix (NFLX) reported $33.7 billion in revenue and $5.4 billion in net income for 2023. That means the company had a net margin of 16.0%:
Net Margin = (5.4B ÷ 33.7B) × 100 = 16.0%
This means that in 2023, Netflix retained about $169 in profit for every $1,000 the company generated in revenue.
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Net Margins vs. Operating and Gross Margins
It’s important to understand the difference between a company’s 3 main Income Statement profitability metrics:
- Gross Margin: Profit after costs of making/delivering the product or service.
- Operating Margin: Profit after all operating costs, including rent, advertising, salaries, etc.
- Net Margin: Profit after all business costs, including taxes and interest payments.
Each metric provides unique insights, but the operating margin is particularly valuable for assessing a company’s operational efficiency.
Why Are Net Margins Important?
Net margins reveal a company’s overall financial health and efficiency. Here are some of the reasons why they matter:
- Measuring Profitability: Higher net margins show that a company can efficiently turn revenue into profit, which is important for sustainable growth.
- Assessing Financial Stability: Net margins offer a clear view of a company’s overall profitability and resilience during difficult times.
- Comparing Across Industries: Net margins help investors compare how profitable companies are within the same industry or peer group.
Companies that consistently maintain higher margins than their peers often have a competitive advantage, such as:
- Cost advantages
- Intangible assets (like a strong brand)
- Network effects
- High switching costs
- Economies of scale
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What Is a Good Net Margin?
A good net margin depends on the industry in which a company operates. Different industries have unique cost structures, competitive dynamics, and pricing power that affect their margins.
Below are some examples of net margin averages for different industries:
High Margin Industries:
- Tech: ~20%-30%
- Luxury Goods: ~15%-25%
Moderate Margin Industries:
- Industrial Equipment: ~8%-15%
- Telecommunications: ~8%-12%
Low Margin Industries:
- Grocery Stores: ~1%-5%
- Logistics: ~2%-5%
- Airlines: ~1%-5%
High-Margin Industries
High-margin industries often enjoy scalable operations, pricing power, and intellectual property that drive profitability.
1. Retail
Industry Average Net Margins: ~20%-30%
Examples:
- Strong Net Margins: Adobe (ADBE) achieves ~30% net margins, driven by its high-margin subscription model and dominant position in creative software.
- Poor Net Margins: Pinterest (PINS) struggles with net margins of around 5% as it invests heavily in user growth and monetization strategies.
2. Luxury Goods
Industry Average Net Margins: ~15%-25%
Examples:
- Strong Net Margins: Hermès (RMS) maintains ~27% net margins due to pricing power, exclusivity, and exceptional demand for its high-end products.
- Poor Net Margins: Tapestry, Inc. (TPR) has net margins of around 10%, impacted by a broader customer base and more price-sensitive product lines.
Moderate-Margin Industries
These industries tend to have some opportunities for companies to scale, but they also have higher cost structures or competition.
1. Industrial Equipment
Industry Average Net Margins: ~8%-15%
Examples:
- Strong Net Margins: Honeywell (HON) sustains ~14% net margins through cost control, operational efficiency, and diverse end markets.
- Poor Net Margins: Deere & Company (DE) operates with ~10% net margins, as its profitability is closely tied to cyclical demand in agriculture and construction.
2. Telecommunications
Industry Average Net Margins: ~8%-12%
Examples:
- Strong Net Margins: Verizon (VZ) achieves ~11% net margins, supported by stable revenue from its large customer base and efficient infrastructure.
- Poor Net Margins: AT&T (T) operates with net margins closer to ~6%, as heavy debt burdens and competitive pressures reduce profitability.
Low-Margin Industries
Low-margin industries are characterized by commoditized products, intense competition, and limited pricing power.
There are definitely wonderful businesses within these industries, but businesses in these industries are generally low-margin.
1. Grocery Stores
Industry Average Net Margins: ~1%-5%
Examples:
- Strong Net Margins: Kroger (KR) maintains ~2% net margins by leveraging scale and optimizing its supply chain to offset razor-thin margins.
- Poor Net Margins: Albertsons (ACI) struggles with margins under 1%, facing fierce price competition and high operating costs.
2. Logistics
Industry Average Net Margins: ~2%-5%
Examples:
- Strong Net Margins: FedEx (FDX) achieves ~3% net margins, relying on efficient route planning and strong demand for e-commerce deliveries.
- Poor Net Margins: XPO Logistics (XPO) operates with margins closer to ~2%, as high transportation costs and competitive pricing pressure impact profitability.
3. Airlines
Industry Average Net Margins: ~1%-5%
Examples:
- Strong Net Margins: Alaska Airlines (ALK) manages ~5% net margins by focusing on efficient operations and a strong regional presence.
- Poor Net Margins: Ryanair (RYAAY) operates with margins closer to 1%, as its ultra-low-cost model faces challenges from fluctuating fuel costs and regulatory pressures.
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Factors That Affect Net Margins
Net margins are influenced by various internal and external factors:
Internal Factors:
- Cost Structure: Companies with lower fixed costs and more flexible cost structures tend to achieve higher net margins, as they can better adapt to fluctuations in revenue.
- Pricing Strategy: Businesses with strong pricing power can maintain high net margins by charging premium prices, even in challenging economic conditions.
- Operational Efficiency: Streamlined operations, automation, and effective cost management can significantly enhance net margins by reducing waste and overhead.
External Factors:
- Market Conditions: Favorable economic conditions, such as strong consumer demand or low interest rates, often lead to higher net margins across industries.
- Competition: Intense competition can pressure companies to lower prices or increase spending on marketing, eroding their net margins.
- Regulations: Regulatory changes, such as new tariffs or compliance requirements, can increase costs and reduce net margins.
Recognizing these factors can help investors spot companies that are likely to improve their margins over time.
How Companies Improve Net Margins
Improvements that a company makes to its gross margins and operating margins will often trickle down to net margin improvements.
However, there are a couple of strategies a company can implement to specifically increase its net margin:
- Reducing Interest Expenses: Lowering debt or refinancing at lower interest rates can directly improve net margins by reducing interest costs.
- Example: Microsoft (MSFT) has strategically reduced its reliance on debt, which has helped the company lower its interest expense and boost its already strong net margins.
- Tax Optimization: Strategies like taking advantage of tax credits, relocating to tax-favorable jurisdictions, or structuring revenue efficiently can help companies lower their tax bill and enhance net margins.
- Example: Alphabet (GOOGL) has utilized international tax strategies, including transferring intellectual property to regions with lower tax rates. This has helped the company lower taxes and maintain high net margins.
- Minimizing Non-Operating Expenses: Reducing one-time or recurring non-operating costs, such as legal settlements or foreign exchange losses, improves net margins.
- Example: Pfizer (PFE) has focused on keeping its non-operating expenses in check by reducing legal and restructuring costs, which has helped to enhance its net margins.
Why Do Net Margins Sometimes Fall?
Net margins can decline for a variety of reasons. If a company’s gross or operating margins fall, net margins will often fall as a result.
We’ll look at some reasons why net margins can fall because of an increase in cost items that impact net margins specifically:
- Rising Interest Expenses: Increased borrowing or rising interest rates can inflate interest expenses, reducing net margins.
- Example: AT&T (T) has faced pressure on net margins due to its high debt levels and increasing interest costs in a rising rate environment.
- Higher Tax Rates: Changes in tax laws or the expiration of tax credits can lead to higher effective tax rates, cutting into net margins.
- Example: Starbucks (SBUX) experienced a decline in net margins when international tax reforms increased its effective tax rate in key markets.
- One-Time Charges: Large, non-recurring expenses such as legal settlements, write-offs, or restructuring costs can significantly reduce net margins.
- Example: Boeing (BA) experienced a steep drop in net margins following massive write-offs and settlements related to the 737 MAX grounding.
- Foreign Exchange Losses: Companies operating in multiple countries are exposed to currency fluctuations, which can lead to foreign exchange losses and lower net margins.
- Example: Coca-Cola (KO) has seen net margins impacted in the past by unfavorable currency movements in emerging markets.
- Non-Operating Losses: Losses from investments, divestitures, or asset impairments can reduce net margins, especially for companies with significant non-core operations.
- Example: General Electric (GE) has struggled with net margin declines due to asset write-downs and divestitures in its restructuring efforts.
- Increased Minority Interests: A rise in profit-sharing with minority stakeholders in joint ventures or subsidiaries reduces the parent company’s net margin.
- Example: Disney (DIS) saw reduced net margins from sharing profits with Hulu’s minority stakeholders before acquiring full control of the platform.
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Frequently Asked Questions (FAQs)
1. What is a good net margin?
A good net margin varies by industry. For example, luxury goods companies may aim for 15%-25%, while grocery stores average 1%-5%.
2. How is net margin calculated?
Net margin is calculated by dividing net income by revenue and multiplying by 100 to determine net income as a percentage of revenue.
3. What factors influence net margins?
Some factors that influence net margins are tax rates, interest expenses, and one-time charges.
4. How can companies improve net margins?
Companies can improve net margins by reducing their interest expense from debt, optimizing their tax bill, and reducing one-time expenses.
5. What’s the difference between gross, operating, and net margins?
The gross and operating margins measure a company’s profitability after certain business expenses, while the net margin reflects a business’s total profit after all costs.
TIKR Takeaway
A strong net margin signals that a company has efficient operations and strong financial management. Analyzing net margins helps uncover businesses with strong competitive advantages.
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Disclaimer:
Please note that the articles on TIKR are not intended to serve as investment or financial advice from TIKR or our content team, nor are they recommendations to buy or sell any stocks. We create our content based on TIKR Terminal’s investment data and analysts’ estimates. We aim to provide informative and engaging analysis to help empower individuals to make their own investment decisions. Neither TIKR nor our authors hold any positions in the stocks mentioned in this article. Thank you for reading, and happy investing!
