Last week's question and answer
Based in California, I market my wares in more than 150 countries and rake in more than $5 billion annually. I was founded in 1945 by H. Matson and Elliot H. Since 1959, I've sold a billion boxes of a flagship product named after my founder's daughter. The product has toiled as a dentist, paleontologist and presidential candidate. I've manufactured more vehicles than all of Detroit. I merged with Tyco Toys and Fisher-Price and have inked licensing agreements with Disney, Sesame Street, Nickelodeon and Harry Potter. Who am I? (Answer: Mattel)
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In the margins
Learn to make sense of companies' financial statements, and valuable insights will be yours. Let's review the income statement (sometimes called the statement of operations) and margins.
The income statement summarizes sales and profits over a period of time, such as three months or a year. It usually offers information for the year-ago period as well, so you can compare the two and spot trends.
Consider Hershey's income statement for 2000. At the top, as with every income statement, you'll find net sales (sometimes called revenues). For Hershey, they're $4.2 billion.
As we work our way down the income statement, various costs will be subtracted from the revenues, leaving different levels of profit. The item you'll find just under revenues is "cost of goods sold" (abbreviated as COGS and sometimes called cost of sales), which represents the cost of producing the products or services sold. For Hershey, it's $2.5 billion. Subtract the COGS from revenues, and you'll get a gross profit of $1.7 billion.
To find the gross margin, which reflects the costs of production compared to sales proceeds, simply divide the gross profit by revenues. Dividing $1.7 billion by $4.2 billion yields a gross margin of 0.40, or 40 percent. (It's often illuminating to compare the results with industry peers. For example, gross margin is 52 percent for Tootsie Roll, a considerably smaller company in the same industry.)
Next, the remaining costs involved in operating the business, such as support staff salaries, utility bills and advertising expenses, are subtracted, leaving the operating profit. Hershey's operating profit is $623 million. Dividing this by revenues yields an operating margin of 15 percent, revealing the profitability of the company's principal business. (Tootsie Roll comes in with a stronger number: 26 percent.)
Finally, after items such as taxes and interest payments are accounted for, we come to net income, near the bottom of the statement. Hershey's is $335 million. Dividing that by revenues yields a net profit margin of 8 percent. This number reflects how much of every dollar of sales a company keeps as profit. (Tootsie Roll: 18 percent.) Examining margins alone, Tootsie Roll is the stronger company.
Patience brings good things
I was employed by General Electric from 1975 to 1981. During this time I had all of my 401(k) invested in GE stock, which had relatively flat earnings and growth. When I left GE, I took all of the 401(k) stock and put it in a safe-deposit box. Since that time, GE has split several times and has had excellent growth. Today I have more than 8,500 shares a sizable nest egg. I was not as knowledgeable about stocks then as I am today. I guess I made the right decision, unknowingly. F.S., Ponca City, Okla.
The Fool Responds: You were smart enough to not jump into actively trading stocks when you didn't know much about them, and to hang on to stock in a company that you were familiar with and saw promise in. Since you hung on after making solid gains, you were able to enjoy further gains. We hope that you own stock in more than just one company, though, as a little diversification is important.