Profitability metrics look at profit from several angles
Profitability metrics measure how well a company generates profit, but the angle depends on what profit is divided by. There are two main branches. Metrics divided by capital (ROE, ROA, ROIC) show how efficiently the money put in produces profit; metrics divided by sales (operating margin, net margin) show how much profit is left from each unit of sales.
Neither branch is more correct; they answer different questions. So rather than looking at one metric, setting several side by side and reading the gaps between them shows where profit comes from.
Three divided by capital: ROE, ROA and ROIC
All three divide a measure of net profit by capital, but the capital in the denominator differs. ROE uses only the equity shareholders have put in, ROA uses total assets including those funded by debt, and ROIC uses only the capital actually invested in the core business.
So ROE shows efficiency from the shareholders' point of view, ROA the efficiency of all assets, and ROIC the efficiency of the business itself, with spare cash and assets unrelated to the core business stripped out. The narrower the denominator, the closer the metric gets to the substance of the business.
If ROE is high but ROA is low, a large part of that high ROE was built using debt as leverage. The gap between the two numbers is close to the size of the leverage.
Two divided by sales: operating margin and net margin
Margins divide profit by sales to show how much of each unit of sales is left as profit. Operating margin looks only at profit from the core business; net margin looks at what is left at the very end, after interest, taxes and one-off gains and losses.
The gap between the two margins hints at what happened outside the core business. If operating margin is high but net margin is much lower, interest costs or one-off losses ate into core profit.
Read together, they show where profit comes from
In short, capital-based metrics show efficiency against the money put in, and sales-based metrics show the profit left from sales. Setting them together separates profit that comes from putting capital to good use, profit that comes from thick margins, and profit inflated with debt as leverage.
Jupick's overall grade groups ROE, operating margin and revenue growth into the profitability area and scores them, while ROA, ROIC and net margin are kept out of the grade and treated as companions for interpreting those three. Every one of these metrics depends heavily on a sector's capital and profit structure, so the most accurate view comes from multi-year trends within the same sector. This content is for information only and is not investment advice.
Frequently asked questions
- How do ROE, ROA and ROIC differ?
- All three divide profit by capital, but the denominator differs. ROE uses only shareholders' equity, ROA total assets including those funded by debt, and ROIC only the capital actually invested in the core business. The narrower the denominator, the closer it gets to the efficiency of the business itself, and a high ROE with a low ROA signals that a large part of it relies on debt as leverage.
- How do operating margin and net margin differ?
- Operating margin is profit from the core business divided by sales; net margin is the final profit left after interest, taxes and one-off gains and losses, divided by sales. A wide gap between the two margins means interest costs or one-off items had a large effect outside the core business.
- Is one profitability metric enough?
- One metric alone makes it hard to tell where profit comes from. Setting capital-based and sales-based metrics together separates profit that comes from putting capital to good use, profit that comes from thick margins, and profit inflated with debt. They depend on sector structure, so multi-year trends within the same sector give a more accurate view.