It's Rishi

I was reading this post by Paul Kedrosky talking about how Amazon’s gross profit margins have been consistently declining since 2001, which sort of contradicts the company’s claim, since its inception, that massive scale will make the business more profitable.

I realized that I wasn’t exactly sure of the the definition of gross profit margin versus operating profit margin. I googled it and found this Income Statement Analysis guide on About.com. Before I knew it, I had spent a good half an hour going through most of it. I found it to be a very practical crash course.

Some interesting things I learned:

1. For asset-intensive businesses, how the company accounts for depreciation is a really important thing to consider. Depreciation methods, rates, and salvage values can make big differences in a company’s bottom-line. More specifically, they can be easily played with to make the company’s earnings look better.
2. EBITDA is BS. Creditors demand interest payments, the IRS demands tax payments, and depreciation and amortization are absolutely real costs of earnings. EBITDA is sexy but really misleading.
3. Comparing operating margin versus gross margin across many competitors in the same industry can tell you a lot about each company’s business models. Like this post that talks about Tim Hortons vs. Starbucks.
4. If a company owns a minority stake (< 20%) of another business, it only reports the actual cash (dividends) it receives and NOT the % portion of earnings that the owning company is entitled to. This profit that the owning company is entitled to but doesn't report is referred to as "look-through" earnings. In one famous example, Berkshire-Hathway, actually had it's look-through earnings exceed it's own earnings, so Berkshire's actual earnings report was a horrible understatement of the company's performance.
5. “Record earnings” don’t necessarily mean jack. ROE (return on equity) is the number to look at. After all, a company which generates the exact same operating income every year, but sticks all its earnings in a 5% interest bank account, will consistently have record earnings simply because of the increased interest income on increased equity. Shareholders can put their own money in the bank and earn that interest. They don’t need a company to do it for them.

Anyways, I would highly recommend you at least browse through this guide if you aren’t already familiar with these concepts. I was somewhat familiar with many of these concepts, but this guide really tied everything together nicely. Thanks Joshua Kennon!