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Friday, June 26, 2009

Calculating Gross Profit Margin Percentage

From The Hoss's Mouth

In today's post, Money Magazine Hoss takes a look at calculating gross profit margin percentage. He will compare the income statements of three companies: General Motors, Amazon and Google. In particular, we will concentrate on the total revenue and gross profit for the years 2006, 2007 and 2008, from which we can calculate the gross profit margin (GPM) for each company for each year.

Why is this number important? Generally speaking, high gross profit margins are considered to be the signs of efficient companies which tend to make decent profits. Investors favor this type of company and are usually willing to pay a higher price per share. This will be clearly demonstrated in our three examples.

Calculating Gross Profit Percentage is not difficult; it is simply Gross Profit divided by Total Revenue.

Let's take a look at the first at the first company Money Magazine Hoss has illustrated for you, Amazon:

Amazon 2006 GPM = 245,600/10,711,000 * 100 = 22.9%
Amazon 2007 GPM = 3,353,000/14,835,000 * 100 = 22.6%
Amazon 2008 GPM = 4,270,000/19,166,000 * 100 = 22.3%

Amazon's GPM has remained constant for the three year period at about 22.5%. A good figure.

Next, Money Magazine Hoss has prepared the GPM for General Motors for the same time frame:

General Motors 2006 GPM = 4,267,000/207,349,000 * 100 = 20%
General Motors 2007 GPM = 12,121,000/181,122,000 * 100 = 6.7%
General Motors 2008 GPM = -1,624,000/148,979,000 * 100 = -11%%

General Motors GPM has been a disaster. Over a three year period it has declined from 20% to a negative figure. Not a company Money Magazine Hoss would invest in.

The third and final company that Money Magazine Hoss selected for the sample three-year period is Google. Take a look:

Google 2006 GPM = 6,379,890/10,604,917 * 100 = 60%
Google 2007 GPM = 9,944,901/16,593,986 * 100 = 60%
Google 2008 GPM = 13,174,044/21,795,550 * 100 = 60%

Google's GPM has remained constant at a very high 60%, which is an excellent Gross Profit Margin.

It is obvious to all that if Gross Profit Margin Percentage was the only criteria an investor was to use in selecting a company to invest in, Google would be the choice. However, as mentioned in Money Magazine Hoss's previous post The Income Statement there are several other criteria which must be taken into consideration. We will be reviewing several of these in future postings.

The June 24, 2009 closing stock prices of Google $409.29, Amazon $79.27 and General Motors $1.11 should not come as any surprise based on their respective Gross Profit Margins. These closing stock prices confirm our statement above: that investors pay higher prices for companies with high Gross Profit Margins.

Stay on track,

The Hoss

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