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http://TheValueatRisk.blogspot.com

October

26,

2009

Focus

on

Operating

Efficiency:

Net

Operating

Profit

Margin

In a previous installment, I covered a measure of after-tax operating profitability known asNOPAT (Net Operating Profit After Taxes)
.

NOPAT serves as a relevant indicator of a firm'sability to operate efficiently, as it strips away many transitory, one-time items from the picture,focusing only on the firm's core business profitability. From an analytical perspective however,NOPAT may be more significant as a numerator of a ratio than as a stand alone measure. Oneof the most important such metrics is the Net Operating Profit Margin (NOPM).Calculating the Net Operating Profit Margin is very easy, assuming however that you canproperly calculate a firm's Net Operating Profit After Taxes.See this postif you need a refresheron NOPAT. Anyways, below is the formula:Net Operating Profit Margin = NOPAT / Sales RevenueHewlett-Packard (HPQ) FY 2008 NOPM CalculationNet Operating Profit Margin = NOPAT / Sales Revenue= \$8591M / \$118,364M= 7.26%To verbalize HP's NOPM of 7.26%, we would say that for every dollar of sales, HP was able togenerate 7.26 cents worth of after-tax operating profit. For many companies, operating profitmargin may be a more concise measure of performance than the commonly cited Gross ProfitMargin. Several small business owners I know are proud of what they perceive to be animpressive gross profit margin at their business. I usually dismiss such talk, as any fool can go

http://TheValueatRisk.blogspot.com

October

26,

2009

out and sell cheaply manufactured products to generate a healthy looking gross profit margin.To pass the NOPM test though, you must be able to operate the organization efficiently andeffectively. Because net operating profit margins vary greatly across industries, it's mostproductive to compare NOPM's across competing organizations within an industry. Below is afocus on HP and it's primary tech industry competitors from a NOPM perspective.

Clearly, industry leaders like IBM and Apple tend to have very healthy net operating profitmargins. There's a little bit of "chicken or the egg" dilemma inherent to that observation; i.e.larger industry leaders are better able to exert their will down the supply chain and operate moreefficiently.Although NOPM is only one element that should be considered when evaluating acompany's/stock's relative investment attractiveness, it is nonetheless a very insightful indicator
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