Profitability Across Industries#

Comparing profitability across industries can lead to misleading conclusions. A 5% net margin might be excellent in one industry and concerning in another. Understanding industry-specific profitability norms is essential for accurate analysis.

Always compare a company's profitability to its industry peers, not to a universal standard. A grocery chain with 3% margins and a software company with 25% margins may both be performing well for their respective industries.

Why Profitability Varies by Industry#

Several fundamental factors drive industry profitability differences:

1. Competition Intensity#

Industry Structure	Impact on Margins	Example
High barriers to entry	Higher margins	Pharmaceuticals (patents)
Low barriers to entry	Lower margins	Restaurants
Network effects	Higher margins	Credit card networks
Commodity products	Lower margins	Airlines, steel

2. Capital Requirements#

Business Model	Typical Margins	Reasoning
Asset-light	Higher margins	Software, consulting
Asset-heavy	Lower margins	Utilities, manufacturing
Inventory-heavy	Moderate margins	Retail, distribution

3. Differentiation and Pricing Power#

Factor	Effect on Margins
Strong brands	Higher (Apple, luxury goods)
Commodity products	Lower (commodities, basic materials)
Switching costs	Higher (enterprise software)
Customer captivity	Higher (subscription services)

Industry Profitability Benchmarks#

Technology and Software#

Metric	Range	Leaders
Gross Margin	60-85%	Microsoft (70%), Adobe (88%)
Operating Margin	20-40%	Meta (35%), Google (26%)
Net Margin	15-35%	Apple (25%), Microsoft (36%)
ROE	20-45%	Apple (160%*), Microsoft (40%)

*Apple's extreme ROE reflects heavy buybacks reducing equity.

Financial Services#

Metric	Range	Notes
Net Interest Margin	2-4%	For banks
ROA	0.8-1.5%	High asset base
ROE	10-15%	Leverage-driven
Efficiency Ratio	50-65%	Lower is better

Healthcare and Pharma#

Metric	Range	Leaders
Gross Margin	60-80%	Driven by IP protection
Operating Margin	15-30%	High R&D costs
Net Margin	10-25%	Patent dependency
ROE	15-30%	Johnson & Johnson, Pfizer

Consumer Staples#

Metric	Range	Leaders
Gross Margin	35-55%	Brand-dependent
Operating Margin	10-25%	Scale matters
Net Margin	8-18%	Procter & Gamble (18%)
ROE	15-30%	Coca-Cola, Nestlé

Retail#

Metric	Range	Leaders
Gross Margin	20-45%	Varies by format
Operating Margin	3-12%	Efficiency-driven
Net Margin	2-8%	Costco (2.5%), Home Depot (10%)
ROE	20-40%	Turnover matters more than margin

Energy#

Metric	Range	Notes
Gross Margin	30-60%	Commodity-sensitive
Operating Margin	10-30%	Highly cyclical
Net Margin	5-20%	Depends on oil prices
ROIC	5-15%	Capital intensive

Identifying Competitive Advantages#

Companies with sustainable competitive advantages (economic moats) show distinctive profitability patterns:

Signs of Competitive Advantage#

Indicator	What to Look For
Margins above peers	Consistently 5%+ higher than industry
Stable margins	Little variation through cycles
Pricing power	Ability to raise prices without losing volume
High ROIC	Consistently above 15%
Long-term trends	Stable or improving over 10+ years

Types of Moats and Profitability#

Moat Type	Companies	Profitability Signature
Brand	Apple, Nike, Louis Vuitton	Premium gross margins
Network Effect	Visa, Facebook, Google	Operating leverage
Switching Costs	Microsoft, SAP	High retention, stable margins
Cost Advantage	Costco, Walmart	Lower margins, higher turnover
Patents/IP	Pfizer, Qualcomm	High margins during patent life

Durability Test

True competitive advantages last for years. Check if high profitability has been maintained for 10+ years. Companies like Coca-Cola and Visa have maintained premium profitability for decades.

Benchmarking Process#

Step 1: Identify True Peers#

Don't compare:

Different sub-industries (luxury retail vs. discount retail)
Different geographies (emerging vs. developed markets)
Different life stages (growth vs. mature companies)

Step 2: Gather Industry Data#

Source	Data Available
Company filings	Direct competitor analysis
Industry associations	Sector benchmarks
Financial databases	Median and quartile data
Analyst reports	Peer comparisons

Step 3: Calculate Relative Position#

Metric	Company	Industry Median	Industry Top 25%
Gross Margin	45%	38%	48%
Operating Margin	18%	12%	20%
Net Margin	12%	8%	14%
ROE	22%	15%	25%

Assessment: Company performs above median, slightly below top quartile—solid competitive position.

Profitability Red Flags#

Warning Signs#

Red Flag	Possible Cause
Margins significantly below peers	Competitive disadvantage
Declining margins while peers stable	Company-specific issues
Margins only high due to leverage	Risky capital structure
ROE > 40% with low margins	Excessive debt dependence
Volatile profitability	Weak business model

Case Study: Struggling Retailer#

Metric	Company	Industry
Gross Margin	28%	35%
Operating Margin	2%	8%
Net Margin	0.5%	4%
ROE	4%	18%
Trend	Declining	Stable

Analysis: Profitability below peers across all metrics with declining trend suggests fundamental competitive problems, not temporary issues.

Practical Framework#

Quick Profitability Assessment#

Gather peer data: 3-5 closest competitors
Compare all margin levels: Gross, operating, net
Check return metrics: ROE, ROA, ROIC
Analyze 5-year trends: Improvement or decline
Identify drivers: Moat or temporary factors
Red flag check: Any concerning patterns

Avoid the High-Margin Trap

High margins alone don't make a good investment. If margins are declining or the company trades at a premium that more than prices in the advantage, returns may disappoint.

Key Takeaways

Compare profitability within industries, not across them
Industry profitability varies due to competition, capital needs, and differentiation
Tech: 60-85% gross margins; Retail: 20-40% gross margins; Banks: 0.8-1.5% ROA
Competitive advantages show as stable, above-peer profitability over 10+ years
Types of moats: brand, network effects, switching costs, cost advantage, patents
Red flags: below-peer margins, declining trends, leverage-dependent returns
Use benchmarking: compare to peer median and top quartile positions