Gross Margin Vs Operating Profit Margin

✅ 1. Definitions

Metric	Meaning	What it reveals
Gross Margin	= (Revenue - Cost of Goods Sold) / Revenue	Measures core value addition; how much profit is made after producing the product
Operating Margin	= Operating Profit (EBIT) / Revenue	Measures overall business efficiency, including marketing, R&D, employee costs, admin, etc.

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 Matthew Berry and his paper “Mean Reversion in Corporate Returns”:

- High gross margins are the most important single factor of long run performance. The resilience of gross margins pegs companies to a level of performance. Scale and track record also stand out as useful indicators.

- That part about pegging means that if a company started with a high gross profit margin, it tended to keep it. Conversely, when it started off with a low gross profit margin, it tended to stay there as well.

- Gross margins persist, to use the statistical lingo. Berry thinks gross margin is a good indication of the price people are willing to pay relative to the input costs required to provide the good. It’s a measure of value added for the customer.

- Operating expenses are volatile. When an underperformer improves, this is often an area where you see the improvement.

- Larger companies appear able to sustain returns for longer by finding efficiencies in SG&A that small companies cannot.

✅ 2. Formula Summary

• Gross Margin (%) = (Revenue – COGS) / Revenue × 100

• Operating Margin (%) = Operating Profit / Revenue × 100

To reverse:

• Operating Profit = Gross Profit – Operating Expenses

• So,
  Gross Margin = Operating Margin + (Operating Expenses ÷ Revenue)

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✅ 3. Real Examples

Example 1: Apple Inc. (Moat via Pricing Power)

From 2023 10-K:

• Revenue: $394.3 billion

• COGS: $223.5 billion

• Gross Profit: $170.8 billion

• Gross Margin: 170.8 / 394.3 = 43.3%

• Operating Profit: $119.4 billion

• Operating Margin: 119.4 / 394.3 = 30.3%

👉 Apple’s moat lies in a high gross margin on iPhones & services, and tight control on SG&A & R&D — making a strong operating margin.

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Example 2: Maruti Suzuki (India): Volume Player

From FY24 Annual Report:

• Revenue: ₹1,37,000 crore

• COGS: ₹1,09,000 crore

• Gross Profit = ₹28,000 crore → Gross Margin = 20.4%

• Operating Profit = ₹13,000 crore → Operating Margin = 9.5%

👉 Even with a modest gross margin, tight control over fixed costs (operating leverage) gives a healthy operating margin.
No major pricing power — moat lies in scale and distribution.

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Example 3: Infosys (Services Business with People Cost)

• Revenue: ₹1,52,000 crore

• COGS (Employee and Delivery Costs): ₹94,000 crore → Gross Margin = 38.2%

• Operating Profit: ₹34,000 crore → Operating Margin = 22.3%

👉 Gross margins are high, but people cost is in COGS. Moat lies in execution, client stickiness, and efficient delivery — not product pricing.

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✅ 4. Quick Estimation: From Operating Margin → Gross Margin

Suppose you know:

• Operating Margin = 12%

• Operating Expenses (marketing, R&D, admin) = 8% of revenue

Then:
Gross Margin = Operating Margin + Operating Expenses/Revenue
→ 12% + 8% = 20%

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✅ 5. Where Does the Moat Lie?

Business Type	Gross Margin	Operating Margin	Moat Source
FMCG (Nestlé, HUL)	High (50–60%)	Modest (20–25%)	Brand, distribution, pricing power
Auto OEM (Maruti)	Low (15–25%)	Low (8–12%)	Scale, network, product mix
Software (TCS, Infosys)	Moderate (35–40%)	Healthy (20–25%)	IP, skilled labor, client trust
Platform (Google, Facebook)	Very High (60–70%)	Very High (30–35%)	Monopoly/duopoly, data, network effects

💡 A company with both high gross and high operating margins often has a strong moat.

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✅ Summary Table

Metric	Reflects	Includes
Gross Margin	Value addition	Excludes R&D, marketing, admin
Operating Margin	Business model efficiency	Includes all core operating costs
Moat Check	Strong brands/services show consistently high gross + operating margins	Look for stability and improvement over time