Question

When comparing EBIT margins within a specific industry, if a company has a much higher EBIT margin than its competitors, does that suggest that the company is more operationally superior?

Answer 1

More often than not a company with a higher EBIT margin than its competitors in the same industry does certainly suggest that the company is more operationally superior. This is because EBIT margin = EBIT/Revenues and is expressed as a percentage. The lower is a company’s amount of operating expenses the higher will be its EBIT margin or operating margin. As such we can say that usually a company with a higher EBIT margin than its competitors in the same industry does certainly suggest that the company is more operationally superior.

However this may not always be the case in all situations and hence we should analyze the financials of the companies in detail before drawing any conclusion. Suppose there are two companies in the consumer goods sector – Company ABC and Company XYZ. ABC has an operating margin of 15% while XYZ has an operating margin of 9% for this year. On analyzing its financials we see that historically XYZ has had better EBIT margins than ABC. This year XYZ has invested large amount of money of plants and equipment as it is expanding its operations across the globe. This increased its depreciation expenses substantially and hence its EBIT was also substantially reduced. Thus even though ABC has a better EBIT margin we cannot say that it is operationally superior to XYZ if the difference is solely due to depreciation amounts.