Course 305: Quantifying Competitive Advantages
Margin vs. Turnover
In this course
1 Introduction
2 Free Cash Flow
3 Profit Margins
4 Turnover
5 Return on Equity and Assets
6 DuPont Equation
7 Margin vs. Turnover
8 DuPont and ROE
9 Return on Invested Capital
10 The Bottom Line

Let's look at the two ways--margin and turnover--that a company can create high returns for itself. Thanks to the several types of moats it possesses, Microsoft (MSFT) is incredibly profitable, with gross profit margins around 80% and net profit margins around 23%. This means for every dollar of sales it generates, its cost of goods sold is only $0.20. Meanwhile, even after all overhead expenses and taxes, it still generates $0.23 in bottom-line profit per dollar of sales.

But Microsoft does not turn over its assets very effectively, having a total asset turnover of only 0.6. Part of this is because a large chunk of its assets are represented by a giant cash hoard that is not generating anything but mere interest income. As such, Microsoft's ROA is "only" 14%.

Wide-moat retailer Wal-Mart (WMT) is at the opposite end of the spectrum. Its net profit margin is only 3.5%, about one-seventh that of Microsoft. However, it turns its assets over 2.4 times. As a result, its ROA is a little over 8% (3.5% times 2.4).

Of course, companies that can create both high profit margins and turnover can generate exceptionally strong returns. Weight Watchers International (WTW) has 17% net profit margins and asset turnover of 1.64, for an ROA of more than 25%--a testament to the firm's wide economic moat.

Next: DuPont and ROE >>


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