'There was a young man from Rexall Who had a hexagonal ball And the cube of its weight Plus the square root of eight Was four fifths of nine tenths of ... Anon. 'Companies monopolising a market do not necessarily make huge profits, business data compiled by the Census and Statistics Department shows. The supermarket trade, in which five companies shared 98 per cent of the market, only enjoyed a net profit margin of 6 per cent. However, property development and leasing firms enjoyed 30 per cent net earnings, even though the five largest corporations occupied 14.4 per cent of the market.' SCMP June 19 LET'S GET THAT BIT about the cube of its weight out of the way first. The five largest property companies have only 14.4 per cent of the market do they? Was that 14.4 per cent each or am I just completely wrong about the weight they swing? Never mind. Add up all of the arithmetic in this latest government study and you still wind up with four fifths of nine tenths of ... ahem ... well, as the limerick suggests ... Of all the measures that have ever been devised of corporate performance, profit margin is easily the most misleading when measuring the profitability of a business. It is certainly no basis for arguing that monopoly positions do not lead to big profits. Let us say that a developer puts down $100 million to construct a building. It will take him about three years after he has made that commitment to get the building up and sold at which point let us say that he finds he has made $30 million in net profit above his $100 million cost, a 30 per cent net profit margin. Okay, this is a highly simplistic picture of how he finances and sells a development but it will do for the purposes of our argument. The argument continues with how a supermarket generates its profit. It sells you a bag of food for $100, makes a net profit of $6 from the transaction (so says the study at least) and then takes its money and uses it to restock its shelves. You then spend another $100 to buy another bag of food from those restocked shelves and the supermarket takes $6 in net profit again. I don't know exactly how frequently your average Hong Kong supermarket turns over its entire stock but let's say it is once a month. This would mean that it recycles its proceeds 36 times over those same three years that a property developer recycles his proceeds once. If on each occasion the supermarket generates a net profit margin of 6 per cent, then over three years that supermarket will have taken $216 in net profit on $100 that has just gone round and round through the till. That strikes me as a better percentage return over that time than the property developer gets, much better. Mind you, I wonder about the 6 per cent figure. Is that truly on a net basis after deducting all costs and across the entire industry? If so, then I think tomorrow I shall give up journalism and start up a Mom and Pop grocery shop. But I suspect that study may have confused profit margin and annual return on invested capital. One tells you how much profit you generated on any given transaction. The other tells you how much profit you generated in any given year on the amount of money you invested in your business. It should hardly be surprising to see a lower profit margin in a business that does not need to invest much and turns its money over rapidly, supermarkets for instance. Equally, it should hardly be surprising to see a higher profit margin in a business that requires heavy investment and turns its money over very slowly, property development for instance. Just keep in mind what the annual return on invested capital is likely to be for each business. I then leave to you to decide whether it should be surprising to see a government study fail to appreciate the distinction. It does not particularly surprise me. But I do know that you yourself look at your business interests in terms of return on invested capital. When you put down $100 you want to know how much profit you will get back and how soon you will get it, whatever you do to generate that profit. It is the way that property developers and supermarket operators look at their businesses, too. If they did not, if supermarket operators decided to close shop at a 6 per cent net profit margin and become developers because developers have margins five times as high, well, as I say, this would be the last column you saw from me and tomorrow I would sell you packaged cereals. But ... pssst ... I know how that limerick ends and I wonder if the authors of this study know that it applies to them.