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Cramer: Gross Margins - Easy as Lemonade

Monday, 22 Apr 2013 | 6:22 PM ET
Cramer: Gross Margins Are Easy
Monday, 22 Apr 2013 | 6:25 PM ET
The term gross margins may sound complicated and confusing, but after Cramer explains it, you'll never struggle again.

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If you're an individual looking to buy stocks, it's critical you understand gross margins.

The concept is so important, Jim Cramer doesn't want you to invest a penny until you fully grasp this key financial concept.

The term gross margins may sound complicated and complex but Cramer doesn't want that to intimidate you. It's actually a simple concept.

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Gross margins are simply what's left after the cost of sales are subtracted.

If you're still scratching your head, Cramer thinks after this example, you'll find the concept of gross margins as easy as lemonade on a hot summer day.

Literally.

In the case of a lemonade stand, "The cost of goods sold are pretty straightforward: the lemons, the water and the sugar," Cramer said. Simple.

"You figure out how much those cost per pitcher, then set a price per cup, and you have the gross margins.

For example – in every pitcher;
4 lemons - $2
1 scoop sugar $0.50
Water – essentially free
Total $2:50

If each glass of lemonade is sold for $1 and there were 8 glasses in the pitcher the revenue per pitcher is $8.

$8 – $2.50 = $5.50 (gross margin per pitcher)

The concept remains the same for every publicly traded company. Of course there are dozens of other variables such as advertising, rent, the cost of training etc but largely the idea remains the same.

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"Gross margins come into play in every industry I follow," Cramer explained. Whatever the sector, Cramer said it's important to track the gross margins from quarter to quarter.

And the trajectory of those gross margins is an excellent way in which to gauge a stock's likely move.

"If you don't know the direction of the gross margins, believe me you won't know the direction of the stock," Cramer added. "It is an integral part of the homework you must do and follow closely."

Call Cramer: 1-800-743-CNBC

Questions for Cramer? madmoney@cnbc.com

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