DAY1 Education : Sustainable Competitive Advantages Explained

Hi, tigers~

Today is the first day of column "Learn US financial reports for beginners".

In this article, I will introduce 2 practical methods of how to judge whether a company has competitive advantage.

  • Total revenue
  • Gross profit

1. Total revenue

You might think, company A with tens of billions of dollars in annual total revenue is much better than Company B with billions of dollars in annual revenue, but is that true? Let me give you an example:

Jack and Rose run separate companies. Jack's company generates $9,000 in revenue per month, while Rose's company generates only $6,000.

From a revenue point of view, you would definitely think that Jack's company is better developed and more competitive.

But if we do a careful analysis and take into account the cost of sales each month, the results may change.As can be seen from the picture, although Jack company has a high revenue, its monthly cost of revenue is also high, and its final gross profit is only $2,850.

However, although the revenue of Rose company is behind that of Jack, the cost of revenue is well managed and the monthly gross profit can be $3,810 dollars.

It can be seen that Rose has more profit funds than Jack in the company every month.At this point, we get to the first conclusion: you can't judge a company by its revenue alone. You may ask, So what should we pay attention to?

This brings us to the second point: gross profit.

2.Gross profit

Warren Buffett, the investment guru, is very good at picking companies.

He once said that gross profit is the key metric of long-term profitability. Only companies with sustainable competitive advantages can maintain profitability over the long term.

What is this gross profit that Buffett takes so seriously? Why does Buffett focus on this number?

Gross profit = revenue-cost of revenue. Cost of revenue is the total cost of manufacturing and delivering a product or service to consumers.However, high gross profit doesn't mean everything.

Buffett said:" Firms with excellent long-term economics tend to have consistently higher margins." In short, there are two key words: "high gross margin" and "consistency".Let's look at the first key word: -- "higher gross margin".

How to calculate gross margin? The basic equation is: Gross margin = gross profit/revenue.


As we have learned that: gross profit = revenue-cost of revenue. Therefore, gross margin = (revenue-cost of revenue)/revenue.Then it becomes a simple math problem.

We just need to find companies in an industry, count their gross profits, then we can find the top companies.I would like to remind you that gross margin varies greatly in different industries.

For example, the software industry has a median gross margin of 59% by the end of 2021. The top 10 companies in this table all have a gross margin over 91%.

The industry leader Microsoft only has a gross margin of 65%.While in the traditional manufacturing industries like auto and auto components industries, the median gross margin is only 16%.

You can tell from this table that the average of gross margin is only 35%, even for the top 10 companies.So different industries have different gross margins, and we must treat them separately.


Let's look at the second key word: "consistency."

If the company can't sustain its high gross margin, its competitive advantage is not consistent. When many companies are facing a crisis, they may also break out a high gross margin for a period of time through some means of financial fraud.

Therefore, it's necessary to identify the feature of "growth" in the income statements. If the growth is not sustainable, the company doesn't have long-term competitive advantage. We need to look at gross margins for the past 5 years or more.

So, Let's summarize what we've learned today :

  1. First, we have learned that we can't simply look at "revenue" to judge whether one company has good profitability or not.
  2. Secondly, we need to focus on the gross profit and gross margin of the company.
  3. Thirdly, gross margin is a key indicator to assess companies' sustainable competitive advantage. Within an industry, companies who have higher gross margin means these companies have higher competitive advantage.
  4. Fourthly, we have learned how to calculate gross profit = revenue-cost of revenue, and gross margin = (revenue-cost of revenue)/revenue.

Okay, have you learned the content of today?  I hope it can help you to understand the US financial reports quickly.

Share your thoughts with me and other Tigers, You can get cions~😎

# Tips For Beginners

Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.

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  • RV726
    ·09-25 19:18
    I am a technical trader. This is a good foundation in fundamental analysis..Looked up Apple's last earnings report. Revenue (sales), Cost of Sales and Gross Margin are top 3 numbers on the report. Look forward to other key fundamentals explained in detail.
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  • ToughCoyote
    ·09-25 19:07
    Thanks @Tiger_Academy for the lesson on revenue computing; i have learnt something new
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  • koolgal
    ·09-25 14:55

    Thanks @Tiger_Academy  for highlighting the importance of knowing how to calculate Revenue and Gross Margin.   These are excellent metrics to know to find out whether a company has sustainable competitive advantages.  Your explanation is very clear and succinct. 

    I look forward to Lesson 2.😍😍😍

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    • 不死鸟.
      谢谢分享
      09-25 15:15
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    • cctv1
      oo
      09-25 15:19
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    • koolgalReplying to不死鸟.
      My pleasure
      09-25 15:55
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  • Mrzorro
    ·09-24 11:26
    Thanks @Tiger_Academy for the lesson.. Good to share with others!
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  • Success88
    ·09-23 18:20
    Thanks for the training. Lean a lot of the recenue. Gross margin learning
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  • Tangen
    ·09-23 17:16
    Great article! I would like to share it.
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  • StickyRice
    ·09-23 17:01
    If gross income margin decreasing then it indicate that the company’s products are costing more to produce/they are selling for less, which might indicate future potential problems with sales/growth.
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  • Papa Bear
    ·09-23 09:05
    Thanks, I learned something valuable today, that high consistent gross margin can also be an indication of competitive moat.
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  • From tiger where can I see the gross margin?
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  • Good information and thanks.
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  • Brocco
    ·09-22
    Market share and volume can indicate potiential branding and competitive level which can help company as long as they control their cost~
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  • Brocco
    ·09-22
    Agree that gross margin is more important than revenue itself as this could be branchmark against other competitors. However, revenue could also show us the overall market share and volume of the co~
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  • verrelrs
    ·09-22
    cool i learn new thing
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    • tbun
      ok
      09-22
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  • Aqaz
    ·09-22
    Total Revenue and Gross Profit are basic items investors first check. Then we look for the revenue and Net Profit. Of cause companies consistently turn in good profit over time are best investments🚀
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    • Aqaz
      ❤️❤️❤️❤️❤️❤️❤️❤️❤️❤️❤️❤️❤️❤️❤️❤️Thanks Tiger_Academy & @Fenger1188
      09-22
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    • Fenger1188Replying toAqaz
      👍🏻👍🏻谢谢❤️
      09-22
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  • AliceSam
    ·09-22
    毛利是衡量长期盈利能力的关键指标。只有具有持续竞争优势的公司才能长期保持盈利能力。
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  • pekss
    ·09-22
    An alternative to gross profit margin is EBITDA margin which removes depreciation & amortisation that are non-cash expenses. It can be used to compare profitability among firms in the same industry.
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    • pekss
      Consistency is key, as we want to identify companies with sustainable EBITDA margin, rather than those boosted by one-off transaction such as asset sale that may not contribute yearly to earnings.
      09-22
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    • evepek
      Yes, I employ EBITDA too!
      09-22
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    • ngph
      I use EBITDA too!
      09-24 09:03
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  • Stingaling
    ·09-22
    I think we also have to analyse the balance sheet to see if companies will run into liquidity problems. And to check the amount of capital they have
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  • rL
    ·09-22
    Thank you! Useful[Strong]
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  • Thanks for the sharing ❤️❤️❤️
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  • Cris0
    ·09-22
    Yes. Total revenue is not an good indicator as company may be increasing revenue from high cost. Gross margin will be a better indicate. Which can be use as as a brenchmarks with other similar company
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