By JLP | April 20, 2009
AFM reader, Chris, left this comment on my post from last week:
What is the profit margin on a bag of cheetos, 50%?? The margin on the gel for my hair is over 100%. Why do we quibble over 1%? Do we expect money managers to work for free? I know it sounds like a lot of money (and it is), but 1% is less than grocery store margins.
The definition of Profit margin (“margin of profit”) according to the Barron’s Finance & Investment Handbook:
The relationship of gross profits to net sales. Returns and allowances are subtracted from gorss sales to arrive at net sales. Cost of good sold (sometimes including depreciation) is subtracted from net sales to arrive at gross profit. Gross profit is divided by net sales to get the profit margin, which is sometimes called gross margin. The result is a ratio, and the term is also written as margin of profit ratio.
In other words, the 1% management expense ratio should not be confused with gross margin. It is simply the fee charged to manage money and is not a margin.
For instance, let’s say I manage a $200 million portfolio for a 1% fee. Not including any other fees, my income for managing this $200 million portfolio would be $2 million per year (not counting any growth in the value of the portfolio). For simplicity’s sake, we’ll assume that the $2 million per year is my net sales. Now lets say my cost of goods sold is $1.5 million per year (seems a bit high to me but I like round numbers), making my gross profit $500,000 per year. Dividing $500,000 by $2 million, makes my profit margin 25%. Not a bad margin, if you ask me.