Online Tutorial #3: How Do You Calculate A Company's Operating Profit Margin?

Changes in operating profit margins can have a significant impact on shareholder value. This session focuses on how to calculate historical operating profit margins (including where to find the data) and how to project margins in the future. As with previous sessions, we will use Domino's Pizza, Inc., as of September 2020, as a case study. Readers who want to calculate operating profit margins while reading this tutorial can download the accompanying spreadsheet.

What Does Operating Profit Margin Mean?

Let's break down operating profit margin into its component parts:

Operating. This means we only include operating expenses in this calculation. Specifically, we exclude all costs associated with financing activities, including interest payments from debt, the financing portion of lease payments, and the amortization of acquired intangibles. Taxes are part of this calculation, which means that it is a pre-tax measure.

Profit. We are calculating profit, or what's left over after subtracting expenses from sales.

Margin. This means we are calculating operating profit as a percentage of sales.

More specifically, operating profit margin equals the percentage of sales left after subtracting the following:

• Cost of goods sold

• General and administrative expenses

• Sales and marketing expenses

• Research and development expenses

• Depreciation of property, plant and equipment.

• Any recurring non-financing expense associated with a company's ongoing operations

We do not subtract the following:

• Interest payments

• Taxes

• Amortization of acquired intangibles

Operating profit margin is equal to EBITA (earnings before interest, taxes, and amortization) margin.

How Do We Calculate A Company's Historical Operating Profit Margin?

Returning to our Domino's case study, we can calculate operating profit margin with public financial statements:

1. Annual SEC 10-K filings. You can access Domino's income statement from its 2019 filings by clicking here. Looking at this page, the information we need comes from this portion of the income statement:

How Do We Estimate A Company's Future Operating Profit Margin?

We can estimate a company's future operating profit margin using one of four methods:

1. Detailed analysis. An example of this analysis is in Expectations Investing. Specifically, on pages 111 and 112, we analyze Domino's historical operating profit margins. We use this historical analysis as a starting point for our estimate of a company's future operating margin. We explain the reasoning, including the impact of economies of scale, behind our estimates of Domino's future operating profit margins on pages 113-115.

2. Value Line. Value Line's company-specific Investment Surveys offer data points that we can use to infer EBITA margins (%) in the past and future. We find Value Line's projections to be a reasonable place to start your margin analysis. Note that Value Line's operating margin adds back depreciation, so you need to adjust down the margin to reflect their approach.

3. Wall Street reports. Analysts in the investment community write detailed reports, often accompanied by lots of historical and projected financial information. If you can obtain these reports, they may be helpful in estimating price-implied expectations.

4. Companies. Because of Regulation Fair Disclosure (FD), companies cannot disclose financial projections selectively to Wall Street analysts or buyside investors. Thus, companies often publish guidance on future financial metrics when they report quarterly earnings. Searching a company's investor relations web site may prove fruitful.