One of the most popular metrics to gauge the strength of a business is its gross margins. Gross margin is a measure of efficiency that is calculated by subtracting a business’ cost of goods sold from its net sales revenue.
In practical terms, gross margins are the percentage of a company’s sales revenue that is retained as profits. For example, a company with 25% gross margins earns 25 cents of profit for every $1 dollar in revenue. That 25 cents can then be used to pay down debt, pay general expenses, repurchase shares of stock or pay dividends.
Why Is It Important?
Investors often use gross margin as a measure of how efficiently a company is running. Two companies in the same business with widely different gross margins is typically an indication that the low-margin company is not maximizing its potential profits. Companies can boost gross margins by cutting costs such as labor and/or raising their prices on goods and services.
Gross margins do not account for ancillary expenses such as marketing, wages, certain operating expenses and taxes. Net margin takes all those factors into account, whereas gross margins are usually simply a reflection of the profitability of a company’s core business.
Gross margins vary widely from business to business, so it may not be particularly helpful to compare gross margins among stocks from different market sectors. However, companies with relatively high gross margins typically have more of a chance of staying profitable if market conditions worsen.
Here are the 11 stocks in the S&P 500 with the highest gross margins, according to Finviz:
Dominion Energy Inc (NYSE: D), 99% margin.
WellCare Health Plans, Inc. (NYSE: WCG), 98.5% margin.
Sempra Energy (NYSE: SRE), 98.1% margin.
Celgene Corporation (NASDAQ: CELG), 96.2% margin.
Incyte Corporation (NASDAQ: INCY), 95.9% margin.
MarketAxess Holdings Inc. (NASDAQ: MKTX), 94.7% margin.
Realty Income Corp (NYSE: O), 94.5% margin.
Tripadvisor Inc (NASDAQ: TRIP), 94.4% margin.
Regeneron Pharmaceuticals Inc (NASDAQ: REGN), 93.4% margin.
Alliant Energy Corporation (NASDAQ: LNT), 93.4% margin.
Northern Trust Corporation (NASDAQ: NTRS), 92.8% margin.
Investors that look at profitability and earnings metrics to value a stock should always take a look at trends in gross margins as well. If gross margins are contracting over time, it may be extremely difficult for a company to maintain its earnings in the long-term.
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