The more effecient a company creates products or provides services, the more profit it generates.
How to use operating margin
- Higher is better
- Above 15% is considered healthy but always compare the company to the industry mean.
- Can be very different between industries
- Can be used to compare companies
Why do investors use operating margin in their analysis
To determine how much profit the company is making from it’s core business.
The three steps every investor should look at:
- What is the current net profit margin?
- How does it compare to the industry?
- What is the trend?
Things to be aware of
- Only compare with other companies in the same industry
- Can be calculated in different ways
How to calculate operating margin
- Operating margin = operating earnings \ total revenue
Real life example
A real life example of Tesla. You need the following data to determine operating margin:
- Operating margin = operating earnings / revenue
- $2,464,000 / $16,934,000 = 0.145 *100% = 14.5%
Operating margin is used to calculate how much profit a company makes after variable costs of production but before paying interest and taxes. Some variable costs examples are wages, raw materials, packaging, and transaction fees. The amount of variable costs is different for each company and industry. In general, a higher operating margin is better as this implicates that a company is running efficiently.
For investors, a higher operating margin is a good sign. Although you should always look at operating margin in the long term. If operating margin is fluctuating over the years this might be a sign that things are not running efficiently enough. It’s a way to check how much profit a company is making from its core business.
Operation earnings can be calculated in multiple ways:
- Operation earnings = EBIT - non operating income + non operating expense
- Operation earnings = Gross profit - operating expense - depreciation and amortisation
- Operation earnings = Total revenue - COGS (costs of goods sold) - indirect costs
Don’t worry about all the terms, I already calculated the operation margin for every company. Just use the search bar at the top of this page and fill in the ticker symbol of the stock you want to check. A healthy operating margin is above 15%. Always compare operating margin between the same type of companies and industries.
How you think about this?