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remain high or be raised—reaps most of the upside from that in-
novation. Profit margins are driven up or down depending on the
degree to which any business—whether GE, Microsoft, Ama-
zon.com, or any other company—can differentiate its products to
earn bran de dpricing an dinnovation power or else be left to bear
the cross an dcosts of innovation.
A warning on profit margins is in order. Very high profit margins
may seem desirable and often are, but they also invite competition
that coul d destroy them. Very low profit margins are worth their
level. Something in between, toward the high end, is ideal.
BANG FOR THE BUCK
“Returns” are a measure of the bang a business gets for its buck.
The bang is always measure din terms of earnings. There are three
bases (or bucks) against which to measure the bang: equity, invest-
ment, an dassets.
In each measure, it is smart to gauge the return over a relatively
long perio dof time—say, five to ten years—rather than over short
periods to get a perspective that tracks a business’s ability to weather
the downsides and reap the upsides.
Return on Equity
Return on equity is the amount a business earns on the capital
owned by its shareholders. Shareholder capital is equal to the total
assets minus the total liabilities. If a business earns $10 million on
shareholder equity of $100 million, its return on equity is 10%.
Returns on equity were relatively high in the late 1990s an dearly
2000s. The S&P 500 average return on equity is aroun d22%. Below
that average are specialty retailers (15%, other than Amazon.com,
whose losses rather than profits give it a negative return on equity).
At or somewhat above the average are GE (about 27%) an dthe con-
glomerate sector (about 25%) as well as the computer industry at
about 25%. Leading the pack is Microsoft (about 34%).
Return on Investment
Return on investment is the amount a business earns on both the
capital owned by its shareholders and the capital supplied by lenders