- As we've just discussed, profitability measures are
in the eye of the beholder.
As you can see here by looking at
the income statement for Nordstrom,
there are a number of profitability measures
on this one income statement.
You can see they disclose a gross margin,
they disclose operating income,
they disclose earnings before taxes,
and they disclose net earnings or net income.
You can also see that they use the terms income
and earnings interchangeably, the point?
When someone uses the term profit or profitability,
you need to ask them to be more specific.
Are they referring to gross profit or operating profit?
Operating profit or net earnings?
You can not expect companies from different industries
to look the same.
We saw that from our DuPont framework.
You can compare the overall measure
of return on equity across industries
but you cannot compare the components
of return on equity across industries.
Now, speaking of the DuPont framework,
let's compute the DuPont framework numbers
for Nordstrom and Microsoft.
Now, we already know which company will have the highest ROE
because Microsoft return on sales was so much larger
than Nordstrom's 15% to 3.6%, or do we?
Let's see.
Microsoft's ROE lays out as follows.
We see their return on sales at 15%,
we see their efficiency at 0.4,
and we see their leverage measure at 3.1%.
The result?
An ROE of 20%, that's a good number.
Many companies aspire to that number.
So let's look at Nordstrom
with their little profitability number of 3.6%.
Examining their DuPont framework, well, we're stunned.
As we know, their profitability measures 3.6%.
Not great but they're efficiency ratio is two,
so that profit margin gets doubled.
But look at Nordstrom's leverage measure, nine,
compared to Microsoft's 3.1.
That amount of leverage jumped their ROE up to 65%.
65%, that's unbelievable.
Nordstrom knocked it out of the park
because of their leverage, not their efficiency
and not their profitability.
But back to profitability.
Be careful when you start hearing numbers
about a company's profitability.
Before you can do any analysis, any comparisons,
you have got to know which profitability term
are we talking about here?