What Is Operating Profit Margin?

Looking at a few different securities in the same industry, but not sure which one is more profitable? Assessing a company’s financial health is key before you decide to invest your hard-earned money. And as an individual investor, it’s crucial to know how to do your own research so you can have complete control of the securities you add to your portfolio.

Profitability ratios like gross, operating and net profit ratios are metrics you can use time and time again when performing research about a potential investment. Choosing the proper equities for you can be easier with the right information and data.

In this article, we delve into what the operating margin entails, how to calculate operating profit margin and how to use this analysis strategy to make well-informed investment decisions.

What Is Operating Profit Margin?

This profitability ratio compares a company’s operating income to its sales. Operating income is earnings before interest and taxes (EBIT).

Operating profit margin indicates how successful management has been in generating income from its core operations. Trends in operating profit margin—positive or negative—are, for the most part, directly tied to management decisions. Overall, operating profit margin shows the amount of revenue brought in during a certain time period that can cover non-operating costs, like paying interest, taxes or other debts.

Among analysts, operating margin is often considered a more valid or reliable profitability measure than net profit margin, as operating income tends to be more difficult to manipulate than net earnings.

What Does Analyzing Operating Profit Tell You?

Companies with higher operating profit margins relative to others in the same industry may control the price of their goods or services more effectively. Additionally, they may be growing sales more than their overall operating costs.

Analyzing operating profit margin can indicate to investors if a company’s is managed poorly or effectively even when salaries, rent and equipment leases are variable costs rather than fixed expenses. When it comes to certain industries, companies may have little control over direct production costs of their goods or services, such as the cost of raw materials to make their products or dependence on other businesses’ support and services.

Additionally, the operating profit margin tells investors a lot about the state of a company’s overall management and business strategy. Management has greater control over selling, general and administrative (SG&A) expenses, so it is important when conducting margin analysis to scrutinize operating profit margin. Trends in operating profit—positive or negative—are, for the most part, directly tied to management decisions. That is why the operating profit margin is typically seen as a superior profitability indicator of a company’s team, compared to net or gross profit margin.

Looking at a company’s past operating profit margin is an intuitive way to gauge whether a company’s performance has been getting better over time.

Before you invest your hard-earned money in a stock, read up on the key financial metrics every investor should know.

How to Calculate Operating Margin

Even though operating profit margin can be found on many financial websites, you may want to learn how to calculate operating margin on your own. The calculation is as follows:

Operating profit margin = [sales – (cost of goods sold + SG&A costs)] ÷ sales

Selling, general and administrative costs are the sum of all direct and indirect selling expenses and all general and administrative expenses of a company

Direct selling expenses are tied to the sale of a specific unit, such as credit, warranty and advertising expenses. Indirect selling expenses are costs generated before or after a sale. These typically include a company’s marketing, advertising and promotion expenses, including web and social media costs. General and administrative expenses include salaries of non-sales personnel, rent, heat and lights.

Knowing how to calculate operating margin helps you to understand the financial strength of companies you are investing in and choose which aspects of a business’ financial health or strength you are interested in focusing on.

How Is the Operating Profit Margin Formula Used to Calculate Profitability?

Operating profit margin measures how much profit a company makes on a dollar of sales after paying costs of production—such as wages and raw materials—that often vary depending on the type of business and industry. However, operating profit specifically excludes interest, other debts and taxes.

Looking at a company’s operating profit over time helps investors to judge whether profitability is improving or decreasing. A steady increase may either be attributed to efficient control of operating costs or other factors that influence revenue buildups such as higher pricing, better marketing and increases in customer demand. A steady decrease in operating profit margin may indicate that the company had one good year versus actual profitability.

The operating profit margin formula also helps to compare the profitability and trends between companies in the same industry.

What Is a Good Operating Profit Margin?

As with the gross profit margin, an investor should look for a relatively high, stable operating profit margin. However, whether a company has a “good” or “bad” margin is determined by its industry. Certain industries, historically, have higher margins than others.

For example, according to AAII’s Stock Evaluator, accommodations platform Airbnb Inc. (ABNB) has a current operating profit margin of 0.9% compared to the online services industry average of around 7%. In a similar industry, leisure and recreation, online rental marketplace Vrbo—owned by Expedia Group Inc. (EXPE)—has an operating profit margin of 4.2%. Vrbo has a higher operating profit margin compared to Airbnb. Such comparisons are most meaningful between companies in similar lines of business.

Looking at the AAII Stock Evaluator ticker pages, Nike Inc. (NKE) has an operating profit margin of 15.5%. Another company in the footwear industry is Crocs Inc. (CROX), which has an operating profit margin of 29.5%. Both Crocs and Nike have operating margins above the industry median of 7.0%. In this instance, even though Nike has an operating margin lower than that of Crocs it is still more profitable than the typical footwear company.

Keep in mind that these percentages are a benchmark; be sure you are looking at a company’s operating profit margin over longer periods of time, rather than just one year.

In the next section, we cover where you can find this data on your own so you can become a well-informed individual investor.

How to Find Operating Profit Margin for Analysis

As we mentioned above, you can find operating profit margin as well as other profitability ratios on the AAII website, as well as numerous other investment education areas. On the AAII website, you can find these margin percentages on the AAII Stock Evaluator pages by typing any ticker into the main search bar.

Once you’ve selected a ticker for a stock such as Nike, you can navigate to the “Ratios” tab where there will be a list of all profitability ratios: gross, operating and net profitability.

On the AAII Stock Evaluator pages, you can review historical data, additional financial metrics, stock grades, etc., for each type of security.

Looking for a convenient tool to filter for stocks that are profitable? Try AAII A+ Investor’s powerful Custom Stock Screener.

What Is the Difference Between Gross, Operating and Net Operating Profit?

We understand that differentiating between gross, operating and net profit may be confusing. Therefore, here we break down the various types of income used to evaluate whether a company is profitable or not.

• Gross income: the most basic accounting measure for a business, it is total revenue minus the cost of goods sold.
• Operating income: a company’s gross income less its operating expenses.
• Net income: profit after all expenses, calculated as sales minus cost of goods sold, SG&A costs, operating expenses, depreciation and other expenses.

Industry comparisons are critical for all profitability ratios including operating profit. Margins vary, so it’s crucial to only compare stocks to others in the same industry. Understand the differences between gross, operating and net income so you can decide how profitable the company is in a given period. A high profit margin relative to an industry norm may point to a company with an advantage over its competitors. The advantage may range from patent protection to a highly efficient operation running near capacity.

How to Use Operating Profit Margin Ratio to Invest

Investors can utilize profitability ratios like operating profit margin to better gauge a company’s financial health. You can use ratios and margins to evaluate the viability of a company and compare it to other companies in similar industries. It is also important to keep in mind that these ratios are interrelated and should be examined together rather than independently.

Knowledge of how to use all three of the main profitability metrics—gross, net and operating profit margins—gives investors a feel for how efficiently a company has generated revenue in the past and how well it might do so in the future. Understanding how a company’s business model and processes generate revenue and earnings—which impacts share prices and shareholders—and how efficient it is at controlling costs are crucial before investing your money into a security.

AAII provides members with helpful educational tools, resources and stock metrics to help them invest their money wisely. With A+ Investor, you can search any company on the AAII website to see specific stock metrics for different investing approaches, including ways to measure a company’s worth and viability.

You can use A+ Investor to vet various market securities like stocks, bonds, funds, etc., with key financial metrics (like operating profit margin), custom stock screeners and power rankings as well as grades. Start your margin analysis on a company today by subscribing to AAII’s A+ Investor.