Every quarter or so (sometimes every six months or so), companies that are listed in Singapore will come out with their updated set of financial statements as part of their earnings announcement. This update will typically include an income statement, balance sheet, and cash flow statement. At first glance, the plethora of financial figures found in those three statements may look intimidating. But, let’s zoom into a couple of those figures that we can easily sink our teeth into. Gross Margins The gross margin can be derived from numbers you’ll find in the income statement. Quick steps to calculate the gross…
Every quarter or so (sometimes every six months or so), companies that are listed in Singapore will come out with their updated set of financial statements as part of their earnings announcement.
At first glance, the plethora of financial figures found in those three statements may look intimidating. But, let’s zoom into a couple of those figures that we can easily sink our teeth into.
The gross margin can be derived from numbers you’ll find in the income statement. Quick steps to calculate the gross margin are here:
- Pick out the revenue and cost of goods sold.
- Next, deduct the cost of goods sold from revenue – that would give us the gross profit.
- If we divide the gross profit with revenue, we get the gross margin.
Pretty straight forward, eh? But what does this margin represent? Here’s a quick take from the Motley Fool’s own book, “Rule Breakers, Rule Makers”:
“Gross margins are a reflection of how expensive it is to manufacture a product relative to the price that it can be sold. A product that costs a lot of money to manufacture, but that can be sold for relatively little, is extremely unattractive.
If it costs you twenty dollars to make a broomstick that you can’t sell for any more than fifteen, you don’t want to be selling broomsticks.
On the flip side, a product that costs very little to make, but that can be sold dearly, is fetching.”
Let’s take software solutions provider Silverlake Axis Ltd (SGX: 5CP) and precision component manufacturer Amtek Engineering Ltd (SGX: M1P) as real life examples. I have summarized the figures needed to calculate the gross margin from the duo’s latest quarter.
Source: Second quarter earnings report from Amtek Engineering and Silverlake Axis
Maybe, the comparison above would not be surprising if we look at the businesses of both companies.
The nature of software means that it does not require much physical material to be included into the final product. Furthermore, the software that Silverlake Axis provides also has high switching costs, thus giving the company the ability to charge a premium for them.
On the other hand, Amtek Engineering needs to directly spend more than $8 of every $10 in revenue on the products that it produces (precision engineering components). This leaves the precision engineering firm with less amount (per dollar of revenue) to invest in the future.
A strong gross margin is a great thing for a company to have, but the financial metric should not be viewed in isolation.
For instance, Foolish investors might still want to think about the growth runway of a company and the potential competitors that may emerge regardless of high the firm’s gross margins are.
The nature of the company’s business is also important to understand. Are its products commodity like? Or does the company have pricing power? It is possible that larger margins can attract competition for commodity-like businesses.
Hang around for the second part tomorrow. Fool on!
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.