Operating Margin

Operating margin is defined as ratio of operating income and revenue of a company. Operating income is the profit of the company before paying interest and taxes. Operating margin is an important financial ratio and analysts look at this number carefully in the quarterly financial statements.

Operating margin is an indicator of profitability of a company. Operating margin tells us how efficiently a company is using its assets. Fund managers and analysts usually like companies with operating margins because they are likely to deliver higher earnings growth. For the same growth rates in revenues, a company with higher operating margins will deliver higher profit after tax (PAT) or earnings per share (EPS) growth compared to a company with lower operating margin. However, investors should not compare operating margins of companies across sectors. For example, capital intensive businesses will have higher depreciation expenses which will impact operating margins compared to less capital intensive businesses. Similarly, businesses which have less pricing power (e.g. commodities) tend to have lower operating margins than businesses with strong brands which have higher pricing power. You should always compare operating margins within the same industry sectors.

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