This may come as a shock but software is the exception. The vast majority of the business world operates this way.
The fun part comes when you realize that absent monopoly conditions this is the natural stable state of a mature market, and think about what the future of software might look like, and what the current public policy fights are about.
I can't figure out where that article gets its numbers from or which banks it's referring to.
The industry standard measure for bank profitability is something called ROA, return on assets, and it's an extensively studied academic topic, with the general consensus that an ROA greater than 1% is pretty good.
I'm sure there are some large institutional players that do consistently better than 1%, maybe up around 5 or 7.
But a longstanding industry with a sustained 24% returns would... sustained compounding 24% a year seems like it would lead to weird results. Like if a bank had survived fifty years and had a few hundred million in assets it would now be responsible for the entirety of US GDP.
I've talked myself into: maybe 24% is technically "profit margin," but only because banks are weird and profit margin makes no sense for them.
If you have a grocery store and you sell $100 of fruit, maybe $1 is profit. It makes sense to say you have a 1% return on investment. $1 Profit / $100 revenue.
That makes sense.
But a bank loans out $100 at 5% interest. It collects $5 next year while the loan is still outstanding, of which $4 go to operating expenses.
That is $1 profit on $5 of revenue, so 20% profit margin, by the formula. But it took $100 to get you there, just like the grocer, so 20% feels inflated for basically the same result. (In other industries you don't sell a peach only for the buyer to later give you a new peach back, so that throws all of this off.)
(You raised ROE, which I think typically ROE for banks is 5-8%, and it's really dependent on random factors like how they treat shareholders, so you might be right? But I think we can set that aside too.)
So none of this makes sense and maybe I give up?
I can see why the industry just decided ROA is the measure here. It's not completely crazy, and seems to generate reasonable results relative to other industries.
And if we're really asking, "hey, I have $100, maybe was loaned it by a lender or depositors, and I can magically run a buffet or a bank next year, what do I expect to earn?"
Then yeah, we really want to be comparing the profit margin of the buffet to the ROA of the bank, as incommensurable as those sound. Maybe this isn't completely crazy and the industry lit has this already figured out in the most reasonable way.
> If you have a grocery store and you sell $100 of fruit, maybe $1 is profit. It makes sense to say you have a 1% return on investment.
Return on investment is something else. A grocery store will have sales well above the invested capital. The profit margin may be low-single-digit while ROI is double-digit.
Good catch, most sources and the link I included hold ROI as equivalent to ROA, and distinguish it from profit margin.
I was trying to shift to a lay voice in that bit and in the process totally misused one of the terms of art under discussion, was a bad oversight on my part.
I think my general explanation stands as to why we might want to shift between ROA/ROI and profit margin when comparing different industries though.
The aren't, which is why you're advised to stay away from financial institutions as a beginning small investor. They require specialized evaluation techniques.
There are less than 5000 commercial banks in the united states and it is very rare a new one is approved. They've been consolidating and the total number declining for decades. Banking isn't a monopoly but it is a very limited, exclusive, club for those with lots of assets.
After all, if you're a bank you can create new money supply out of thin air by lending out money you don't have (fractional reserve). A money printing machine is a very valuable business. Every other service a bank provides is just icing on top of this.
Fractional reserve is lending out money people give the bank. it's not free money for the bank; the credit is balanced by a debt. You can do the same thing if you convince people to leave stuff at your house and then you rent it out.
Heck, every lessee on Airbnb is doing this.
As is everyone who has a mortgage and an investment account.
Software is not really an industry though, it’s just sometimes grouped that way because it’s relatively new. The thing that makes margins low in general is commoditization and the relatively high COGS of physical materials and manufacturing costs. In pure software plays COGS is generally extremely low so there is no cost floor (hence freemium), but also the product can be literally any conceivable logic or data processing which means it can only be commoditized along more specific market lines.
Consider for example the forces driving Uber/Lyft margins vs Google/Facebook margins.
This is the same reason that ILM/Lucas expanded to Asia...
A quote from Lucas at the time they were looking to build Singapore was "Why should I pay some prima donna animator in the US $80k when we can get several in Asia for that price with no complaints"
Yes, this was actually said by an exec at Lucas...
The fun part comes when you realize that absent monopoly conditions this is the natural stable state of a mature market, and think about what the future of software might look like, and what the current public policy fights are about.