Investor Education: Study Operating Profit Margin Ratio before you buy a stock

Operating Profit Margin is essentially operating profit/net sales. Operating profit (also known as EBIT) is net sales - operating expenses (input costs, processing costs, and costs that vary).  You can find these numbers in a company's income statement. Operating profit margin is calculated before taking into account depreciation and tax. Hence, it's a nice measure of how a company is performing in a particular macro economic environment. If the cost of production goes up, margins can be squeezed, and companies will have a hard time to compete effectively. Consumer discretionary items like  autos and capital goods are suffering now because of high input costs.


Companies that can pass on these added costs to consumers without affecting their sales can be leaders in that space and can retain their profitability. If they cannot pass it on, their margins get affected. Companies with superior operating profit margin have a better chance to be profitable in various economic environments. 


When buying a stock, compare the operating margins with it peers. Check out the table below that compares the operating margin of the top 3 auto companies in India. Which one is better? 

Ticker	Audited	MCap	Total Assets	Net Sales	Adj PAT	Op Margin	Adj Net-Margin	ROCE	Adj P/E(TTM)	P/Book	Debt/MCap
BAJAJ-AUTO	2010	37,648.6	4,266.9	11,508.5	1,784.4	15.7%	15.5%	57.1%	15.1	12.9	0.0
HEROHONDA	2010	31,954.0	3,531.1	15,758.2	2,081.8	15.7%	13.2%	81.4%	16.0	9.2	0.0
TVSMOTOR	2010	2,532.3	1,868.6	4,363.1	111.5	0.5%	2.6%	8.2%	13.1	2.9	0.4

Source:capital4

The escalating input costs has adversely affected TVS Motor's operating performance. Hence the stock has performed poorly lately. TVS's operating profit margin is much lower than Hero Honda & Bajaj Auto. The input costs continue to remain high and TVS is expected to underperform in the short term. Bajaj Auto  has a better adjusted net margin than Hero Honda. Note that Hero Honda has a much better ROCE than its peers (More on how to use ROCE in another post.)


It's important to monitor operating margins every quarter to see as to how companies adjust to changing economic scenarios. Net profit margins, which take into account all costs including income tax is the stringent way to assess profitability. Operating margins give a nice view on the operational efficiencies of the company.