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Company X has annual revenue of 100 million, and net profit of 20 million. Profit margin = 20/100 = 20%

Company Y has annal revenue of 500 million, and net profit of 20 million. Profit margin of = 4%

Both companies are in different industries and their profit margins roughly stay the same, and Company X can't just grow their revenue to 500 million from 100 million as there is little/no growth in revenue.

So would it matter when evaluating stocks, if both stocks are earning the same profit of 20 million (constantly)? Does it matter that Company Y takes in 500 million revenue?

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If we accept all of your assumptions (profits are constant, revenues cannot be grown), then these stocks seem very little like stocks and very much like perpetual bonds.

And under those assumptions, it probably doesn't matter that their revenues are very different.

Whether your assumptions are realistic is a different matter....

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Both companies are in different industries

That is the catch. Never compare oranges with apples. Utility companies, airlines don't earn such high profits as it is the nature of their industry. You cannot compare them with a biotech firm or a technology firm(Apple) who are minting money. It is the nature of their industry.

Utility companies are high investment requiring industries(at the start, you can see why utility companies are resisiting modernization in the US) and they earn their money slowly. So it will be wrong to compare them against a technology firm, where investment is low.

Now supposedly if X and Y are in the same industry.

A 100 million dollar firm is probably manufacturing good products, for which it is charging a premium which is pushing up it profits. While 500 million firm has been probably there for long and has run out of ideas. Or they might be investing heavily in their R&D(which is an expense) which is pushing down their profits. Or they might be hæmorrhaging cash in some inept investment.

So there is no single answer. The circumstances have to be considered before coming to a decision.

  • Except he obviously is comparing these companies because he's trying to deciding where to invest. Sometimes you have to compare apples and oranges, because you're not hungry enough to eat both! I do agree there is no single answer though, it's not so simple. – Jared Aug 22 '14 at 14:13
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There's not enough information to say.

For example, if both companies had a billion dollar loan, Company A will be in a lot of trouble if profits decline whereas Company B would still have room to maneuver.

Similarly, management styles will matter a lot more than simply net profit. If management is trying to cook the numbers to look better than they are, instead of focusing on innovation and/or cost control, the same profit today may be vastly different tomorrow. Likewise, if they misjudge the industry they are in, and either embark on bad projects or don't consider good ones, then it could affect the company's performance in the future. None of that can be captured by net profit alone, and in general you should never boil down an investment decision down to a single variable.

You also can't compare companies directly that way if they span different industries. For example, a 20% margin might be terrible for the fashion industry but amazing for a utility, and 4% margin might be amazing for a nail manufacturer but terrible for a software company. So the more applicable comparison would be, what are the profit margins of other companies in the same industry, and how does this one compare? The first might be making 20% in an industry that typically makes 50%, and the second might be making 4% in an industry that typically makes 2%.

Other things to consider are ROE and ROTA, how much of an asset base does the company have, compared to the money it's generating? All of that will determine the financial stability of the company, and also gives an idea of how efficient the companies are at using their assets: What if Company A has an asset base of $1 Billion and Company B has an asset base of $500 Million, then Company A is barely making money off its assets while Company B is generating it's own assets worth of revenue in a year. Definitely things to consider as well.

All in all, there's a danger in making investment decisions off of a simple accounting ratio like that, executives are well aware of lots of ways to distort the numbers (if they are doing that it's a huge warning sign but you need more information to know!), and it may mean different things to different industries at different times. So, if you're trying to compare two companies, make sure you're using the right measuring sticks, and by all means use more than one!

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agree with @DumbCoder comparing companies in different industries is tricky. although i'll disagree on which company is the better investment(assuming same industry) the company with $500m revenue is more stable and can always grow profit since it's easier to increase margins as opposed to growing sales. also the $500m company will probably have cheaper costs of capital which with good management translates in more shareholder value and R&D investment (google-esque).

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