Low-operating leverage companies may have higher variable fixed costs but lower fixed costs. And that leverage also translates into the volatility of the operating income or operations of the company.Ĭompanies with higher operating leverage carry higher fixed costs regardless of whether they do $1 of sales or millions. Thinking simply, a company’s operating leverage translates revenue growth into operating income, or EBIT (earnings before interest and taxes). A business that generates sales with a high gross margin and low variable costs has high operating leverage.”
“Operating leverage is a cost-accounting formula that measures the degree to which a firm or project can increase operating income by increasing revenue.
Operating leverage, according to Investopedia, is: Okay, let’s dive in and learn more about operating leverage. Context matters, and it is important to keep that idea in mind. For example, comparing the operating leverage of Apple to GM is not a fair comparison, but comparing Apple to Microsoft is a more reasonable comparison. Keep in mind that each industry will have different degrees of operating leverage. The better operating leverage a company owns, the quicker the company can scale up as it grows, the lower the leverage the opposite is the case.Īnother benefit to studying operating leverage is seeing management efficiency in action: better management in controlling costs, and focusing on efficiencies across the board which will lead to better results. Operating leverage is one of the more important considerations when analyzing a company, but it is one of the more underutilized ideas. Investors who are able to forecast earnings in a year’s time that are substantially different than today’s expectations can earn meaningful excess returns.” Sources of those revisions include fundamental outcomes (typically earnings revisions) and an assessment of how the market will value those fundamentals (multiple expansion or contraction). “For a fundamental investor, anticipating revisions in expectations is the key to generating attractive returns.