Income Statement Insight: Gross Margins Matter

Margin Movement

Change in gross margin is also really important. There are countless conditions that can affect a company's margins, and poor margins one year shouldn't necessarily be the deathblow for an investor.

For example, Apple (AAPL) recently saw their margins jump 6.6% (from 30.3% in the first quarter of 2007 to 36.9% in the second quarter of 2007) -- a feat that may have made up some ground against inflated analyst iPhone expectations.

Remember, though, that downward movement can be an ominous sign of things to come -- losing suppliers, tough changes in materials prices and labor negotiations can all drive gross margins down in a lasting way (see "Alcatel-Lucent Swings to Loss").

Gross Profit

While percentage measures like gross margin are great to use comparatively, gross profit provides investors with an absolute measure that's useful in measuring a company's scale. High gross margins are great, but if the company's sales are not enough to make a profit in the first place, their per-unit gross margins become a bit of a moot point.

In the same vein, watch out for companies whose income statements show stifling general, selling, and administrative expenses (these are reported as line items on the income statement) -- they can really muddle up that gap between gross profit and the bottom line (see "Getting Started: The Income Statement").

Margin Watch

Gross margins are an integral part of analyzing a company's income statement. They give investors guidance as to per-unit profitability, and can be immeasurably useful in predicting future performance. Watching a company's gross margins is a great way to make sure that you're not marginalizing the gains in your portfolio.

>To order reprints of this article, click here: Reprints