Operating Margin

Operating margin or the operating profit margin is a measure of a company's efficiency. It indicates how much of revenues (or pre-tax profit) is left after all the operating expenses have been paid out, expressed as a percentage of total revenues. We can calculate operating income margin as follows:

Operating Margin = Operating Earnings/ Revenues

The operating earnings is derived by subtracting expenses like the cost of goods sold or COGS, labor and the everyday expense a company incurs in running its core business, from the revenue. This expense does not include one-time expenses like one time transactions or accounting adjustments.

Operating Earnings = Revenues - (COGS + Selling General & Admin expense + R&D expense + Depreciation Depletion Amortization)

Operating Margin for Internet Companies

The operating margin makes sense when it is compared for companies within the same industry. It will not make sense to compare a company like Google (NASDAQ:GOOG) which is the online search giant, with say a company like Gerdau S A (NYSE:GGB). Google being an internet stock will have operating expenses which comprises majorly of employee cost, the server costs, and the activities which go in to selling advertisement space. Whereas, for Gerdau, which provides crude steel and stainless steel products worldwide, the operating expense will come from the raw materials, manufacturing costs, and selling costs involved in making the finished product.

Understanding Operating Margin

When using the operating margin of a company to make an investment decision, one must look at it for a period of time. An increasing operating margin over time could mean an efficient operating model employed by the company. The converse, that is declining operating margins could mean either that that the company.s core business itself is not doing well, or the cost involved in creating the business/ service is increasing with time.

Google operating margin

Google operating margin for last 5 years

Revenue (in millions USD)59,83050,18037,91029,32023,650
Operating Earnings (in millions USD)13,97012,76011,74010,3808,310
Operating Margin (as %)23.3525.4330.9735.4035.14

Gerdau S A operating margin for last 5 years

Revenue (in millions USD)17,42019,33019,88017,37011,050
Operating Earnings (in millions USD)1,2601,2001,6901,8708,110
Operating Margin (as %)

The above table and chart shows the operating margin for Google in comparison to the company Gerdau S A. What we see is that internet companies generally enjoy a higher operating margin than manufacturing companies, as their operating expenses tend to be lower.

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