Margins matter. The more Elan (NYSE: ELN) keeps of each buck it earns in revenue, the more money it has to invest in growth, fund new strategic plans, or (gasp!) distribute to shareholders. Healthy margins often separate pretenders from the best stocks in the market.  That's why I check on my holdings' margins at least once a quarter. I'm looking for the absolute numbers, comparisons to sector peers and competitors, and any trend that may tell me how strong Elan's competitive position could be.

Here's the current margin snapshot for Elan and some of its sector and industry peers and direct competitors.

Company

TTM Gross Margin

TTM Operating Margin

TTM Net Margin

 Elan 50.3% 7.1% (27.3%)
 Johnson & Johnson (NYSE: JNJ) 69.7% 26.6% 21.8%
 Par Pharmaceutical (NYSE: PRX) 34.5% 12.7% 8.0%
 Watson Pharmaceuticals (NYSE: WPI) 44% 14.5% 6.6%

Source: Capital IQ, a division of Standard & Poor's. TTM = trailing 12 months.

Unfortunately, that table doesn't tell us much about where Elan has been, or where it's going. A company with rising gross and operating margins often fuels its growth by increasing demand for its products. If it sells more units while keeping costs in check, its profitability increases. Conversely, a company with gross margins that inch downward over time is often losing out to competition, and possibly engaging in a race to the bottom on prices. If it can't make up for this problem by cutting costs -- and most companies can't -- then both the business and its shares face a decidedly bleak outlook.

Of course, over the short term, the kind of economic shocks we recently experienced can drastically affect a company's profitability. That's why I like to look at five fiscal years' worth of margins, along with the results for the trailing 12 months (TTM), the last fiscal year, and last fiscal quarter (LFQ). You can't always reach a hard conclusion about your company's health, but you can better understand what to expect, and what to watch.

Here's the margin picture for Elan over the past few years.

Eln


Source: Capital IQ, a division of Standard & Poor's. Dollar amounts in millions. FY= fiscal year. TTM = trailing 12 months.

(Because of seasonality in some businesses, the numbers for the last period on the right -- the TTM figures -- aren't always comparable to the FY results preceding them.)

Here's how the stats break down:

  • Over the past five years, gross margin peaked at 62.5% and averaged 55.7%. Operating margin peaked at (1%) and averaged (27.7%). Net margin peaked at (7.1%) and averaged (40.4%).
  • TTM gross margin is 50.3%, 540 basis points worse than the five-year average. TTM operating margin is 7.1%, 3,480 basis points better than the five-year average. TTM net margin is (27.3%), 1,310 basis points better than the five-year average.

With negative TTM net margins, Elan clearly isn't doing well. But the better operating and net margins compared to historical averages should give Elan some confidence that things are turning around for the company.

If you take the time to read past the headlines and crack a filing now and then, you're probably ahead of 95% of the market's individual investors. To stay ahead, learn more about how I use analysis like this to help me uncover the best returns in the stock market.  Got an opinion on the margins at Elan? Let us know in the comments below.

Elan is a Motley Fool Rule Breakers recommendation. Motley Fool Options has recommended a diagonal call position on Johnson & Johnson, which is a Motley Fool Income Investor recommendation. The Fool owns shares of Johnson & Johnson. Try any of our Foolish newsletter services free for 30 days.

Seth Jayson owned shares of the following at the time of publication: Elan, Johnson & Johnson. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.