Investors looking for industries with large potential returns need to be concerned with profitability. A number of macroeconomic factors that create the business environment affect every industry. These factors cause some industries to be inherently more profitable than others. Analyzing an industry's gross profit margin will help you recognize which industries have a favorable business environment.
Gross Margin
-
Gross Margin is a percentage calculated by dividing revenue by gross profit. Revenue is the net sales of a company, while gross profit is net sales minus any costs of production. For a manufacturing industry, the costs of production are the raw materials, labor and overhead that go into creating the product. In retail, the cost of production is the amount paid to acquire inventory. This calculation gives you an idea of how much producing a good or service affects an industry's profit generation. It also represents the residual resources that can fund operations.
Cost of Goods Sold
-
Cost of goods sold is the accounting term assigned to costs of production. Gross margin is a useful tool for analyzing the associated production costs in an industry. A low margin indicates potentially high input costs -- for example, the cost of labor may be high. Service industries tend to have lower costs of goods sold, as the product sold is expertise and there are not many costs associated with producing the service.
Revenue Generation
-
Gross margin is also a good measure for an industry's ability to generate revenue. High levels of competition in an industry can lower the prices consumers are willing to pay. Industry price wars to grab market share lower industry profit margins. Conversely, high levels of demand can widen the margin that industries earn by allowing higher prices in comparison to input costs.
Industry Examples
-
The factors influencing gross margins are evident when looking at specific industry averages. For example, the legal service industry has, on average, a gross margin of 93.22 percent, according to Butler Consultants. Because this industry is a service, it has low production costs, but it is also a specialized profession that is in high demand. A higher gross margin is the result. The car dealer industry, on the other hand, has large fixed costs associated with building an inventory. Additionally, competition from other dealers is part of the industry environment. As a result, the average gross margin for the industry is only 14.4 percent.
