How does the company...
make money?
...and why it matters.
By Manuel Maurício
May 23, 2022
Do you know how McDonald’s makes money?
Selling burguers?
Collecting franchising fees?
Think again.
McDonald’s makes more money from leasing its stores to the franchisees than from collecting royalties. When the franchisee sells fewer burguers, McDonald’s raises the rent to compensate for it.
When you’re researching a new company, you need to be able to explain how it makes money. And sometimes it isn’t obvious.
Take DaVita for example. DaVita is one of the two largest dialysis providers in the USA. After a bit of research you might reach the conclusion that it makes money by performing dialysis services. And it does. But does that mean that you really know how it makes money?
Well, 70% of DaVita’s revenue comes from Government funds. But that revenue isn’t enough to cover the costs. It’s the other 30% of revenue, coming from commercial private insurers (with much higher margins) that allows for the company to turn a profit.
Why does this matter, you might ask. Well, let’s say that DaVita’s revenue suddenly drops by 5%. You might be thinking that it will be making 5% less profit when in reality it might mean that 17% of the profits just went up in smoke (5% of 30%).
Now to one of my favorite ones, Ryman Healthcare from New Zealand. Ryman builds and operates retirement villages. Healthcare is a good business, right? Wrong. The healthcare segment doesn’t make enough money to cover the costs.
The way it makes money is by selling the houses to the old folks. Once they pass away, the company will get the house back and will resell it for a higher price. Ingenious, right?
So, you might’ve been looking at McDonald’s thinking that it made money selling burguers, at DaVita thinking that the Government was its cash cow, and at Ryman thinking that you had been looking at a healthcare company when in fact you had been looking at a real-estate company.
I encourage you to do the following exercise, for each of the companies that you own, explain how they make money in a couple of sentences.
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