Profitability ratios show how efficiently a company turns sales and capital into profit. They separate genuinely good businesses from merely big ones.
Margins: profit per dollar of sales
| Margin | Formula | Tells you |
|---|---|---|
| Gross | Gross profit / Revenue | Pricing power and product economics |
| Operating | Operating income / Revenue | Efficiency of the core business |
| Net | Net income / Revenue | What's left after everything, incl. tax & interest |
Returns on capital: profit per dollar invested
Margins tell you profit per sale; returns on capital tell you profit per dollar of money tied up in the business. The big three are ROE (return on shareholders' equity), ROA (return on assets) and ROIC (return on all invested capital). A durable, high return on capital is one of the strongest signs of a quality business and a competitive moat.
Watch the source of a high ROE: it can come from fat margins and efficient operations — or simply from piling on debt. ROIC strips out the financing effect, so comparing ROE to ROIC quickly reveals which it is. See the dedicated ROIC vs ROE vs ROI guide.
Quality over a single year
One strong year can be luck or accounting. Look for high returns and stable-or-rising margins sustained across at least 5–10 years — consistency is the signal.
