Revenue vs Profit: Key Financial Metrics Explained Simply
Introduction
When developing an investment strategy, a key element is a company's ability to generate revenue and convert it into profit. Revenue shows the scale of sales, while profit reflects the efficiency of cost management. Understanding their differences and interconnections helps investors assess the sustainability of a business, forecast growth, and avoid mistakes when selecting stocks. This guide reveals the definitions, structures, analytical methods, and practical applications of these metrics.
In this article, we will explore real examples from different industries, examine cases of well-known companies, and provide templates for independent analysis, so every investor can apply their knowledge in practice.
Basics of Revenue and Profit
Understanding Revenue
Revenue is the total amount of funds received by a company from the sale of goods or services. There are three main types of revenue:
- Gross Revenue – all receipts before deducting discounts, returns, and taxes.
- Net Revenue – revenue minus returns, discounts, and indirect taxes.
- Operating Revenue – income from core activities, excluding non-operating items.
For example, Netflix's revenue is segmented into subscription income, licensing, and advertising revenue, allowing analysts to assess the contribution of each segment.
Understanding Profit
Profit indicates how much money remains after all expenses and taxes are paid. The main types are:
- Gross Profit = Revenue − Cost of Goods Sold (COGS).
- Operating Profit = Gross Profit − Operating Expenses (SG&A, R&D).
- Net Profit = Operating Profit + Non-operating Income − Interest Expenses − Taxes.
For example, a smartphone manufacturer may have high revenue, but operating profit may decline due to investments in R&D and marketing to maintain competitive advantage.
Revenue vs Profit
Revenue demonstrates market demand and the scale of the business, while profit reflects efficiency in cost management. Tesla generated billions in revenue for many years while remaining unprofitable due to high capital expenditures; however, investors focused on revenue growth saw substantial returns when the company became profitable.
Structure of the Income Statement
Key P&L Items
- Revenue
- Cost of Goods Sold (COGS)
- Gross Profit
- Operating Expenses (SG&A, R&D)
- Operating Profit
- Interest Income and Expenses
- Taxable Income
- Net Profit
Analysis of notes to the statement helps identify one-time items, such as income from the sale of subsidiary assets, and exclude them from operational evaluations.
The Impact of Structure on Analysis
Technology companies often segregate revenue from cloud services and subscriptions, allowing for an assessment of revenue stream stability. For industrial manufacturers, revenue segmented by region and product shows where the company is growing faster and where optimization is needed.
Margin and Profitability
Gross Margin
Gross Margin = (Gross Profit / Revenue) × 100%. This reflects the efficiency of production and purchasing: for Microsoft, it exceeds 65%, while for grocery retailers, it rarely exceeds 30%.
Operating Margin
Operating Margin = (Operating Profit / Revenue) × 100%. A high margin indicates effective cost management. Google exhibits an operating margin of over 25% due to low operating costs per user.
EBITDA Margin and Net Margin
EBITDA margin helps to compare companies with different depreciation and debt policies. Net margin shows the final share of income remaining to shareholders. Values below 10% are typical for retail, while those above 20% are common for IT and pharmaceuticals.
Factors Influencing Margins
Margins depend on the company's pricing power, cost structure, scale of business, and level of automation. Apple maintains high margins due to a premium pricing strategy, while Walmart achieves this through bulk purchasing and high turnover.
Dynamics and Quality of Revenue
Revenue Growth Rates
Growth rate = ((Current Revenue − Previous Revenue) / Previous Revenue) × 100%. It is important to analyze both annual growth and CAGR over several years. Zoom displayed a revenue growth rate of over 300% in 2020, but then the rate stabilized — indicative of the company's life cycle.
Assessing Revenue Quality
The quality of revenue is determined by the share of recurring payments, client diversification, and the stability of pricing models. Salesforce generates over 75% of its revenue from subscription models, ensuring income stability.
Seasonality and Cycles
Seasonal fluctuations are particularly pronounced in tourism and retail: reports during Black Friday or holiday periods significantly impact quarterly revenue. For seasonal businesses, quarterly comparisons require adjustments for calendar effects.
Valuation Multiples
P/S (Price-to-Sales)
P/S = Market Capitalization / Revenue. This is suitable for valuing growing but unprofitable startups. With P/S=10, an investor pays 10 ZAR for every ZAR of revenue.
EV/Sales
EV/Sales = (Market Capitalization + Net Debt) / Revenue. This is more precise, taking into account debt load and the impact of capital structure.
Industry Norms
Technology: P/S=5–15; Pharma: 3–8; Retail: 0.5–2. High P/S ratios are justified by high growth rates and margins, while low ratios reflect stability and dividend payments.
PEG for Revenue
Adaptation of the PEG model: PSG = P/S / Revenue Growth Rate. A PSG value below 1 indicates an attractive price given the stated growth rates.
Comparative Analysis and Benchmarking
Peer Analysis
Select similar companies within the same sector and compare revenue growth rates, margins, and multiples. For example, a comparison between Shopify and BigCommerce highlighted higher growth rates for Shopify at similar P/S ratios.
Market Share through Revenue
Share Calculation = (Company Revenue / Total Market) × 100%. An increase in share indicates the company's strategy is successful in competitive battles.
Practical Tools and Data Sources
Sources
- Annual and quarterly reports (10-K, 10-Q, IFRS, RAS).
- Portals such as Yahoo Finance, Google Finance, Investing.com.
- Professional terminals like Bloomberg, Refinitiv, FactSet.
- Regulatory databases: SEC EDGAR, company websites.
Analytical Tools
Excel and Google Sheets are the primary tools for modeling. Python with pandas and matplotlib is used for automating data collection and visualization. Stock screeners (Finviz, TradingView) allow investors to quickly filter companies based on revenue, margins, and multiples.
Model Templates
A typical model includes historical revenue and profit data, seasonality analysis, scenario forecasting, and benchmarking. Regularly updating data and testing forecasts against actual reports helps improve accuracy.
Risks and Limitations
Revenue Distortions
Companies may accelerate revenue recognition by changing payment terms or splitting contracts. To verify, one should analyze the cash flow statement (CFO) to ensure revenue aligns with actual inflows.
Macroeconomic Risks
Revenue depends on inflation, currency fluctuations, and interest rates: exporters benefit from a weak currency, while firms with fixed costs suffer from high inflation.
Stress Testing
Scenario analysis (base, optimistic, pessimistic) helps assess revenue sensitivity to key variables and identify major risks.
Integration into Investment Strategy
Growth vs Value
Growth investors seek high revenue growth rates and are willing to pay premium multiples. Value investors focus on stable revenue and profits, evaluating companies based on low P/S and P/E ratios.
Balanced Portfolio
Diversification is achieved by combining companies with different growth rates and margins: tech startups, stable consumer giants, and cyclical commodity companies.
Portfolio Example
An example of a diversified portfolio: 40% in fast-growing tech companies, 30% in stable consumer goods firms, 20% in the financial sector, and 10% in cyclical industries.
Conclusion
Revenue and profit are the foundation of fundamental analysis, revealing the scale and efficiency of a business. Their combined analysis, taking into account margins, multiples, and macroeconomic context, allows investors to make informed decisions. Apply the proposed methods and tools to evaluate companies' financial health and develop a successful investment strategy.
