Definition
Operating Leverage
Operating leverage is the degree to which a company's profits rise or fall with sales, driven by its mix of fixed versus variable costs.
A business with high fixed costs has high operating leverage: once it crosses break-even, additional sales drop largely to profit, so earnings can soar as revenue grows (and crash sharply when sales fall). Capital-heavy sectors like cement, steel, and hotels show strong operating leverage.
Investors look for companies entering an operating-leverage phase, where rising capacity utilisation rapidly expands margins. The flip side is high risk in downturns, since fixed costs persist even when revenue drops.
Related terms
- EBITDAEBITDA is earnings before interest, tax, depreciation, and amortisation, a measure of a company's core operating profitability.
- Operating MarginOperating margin is the percentage of revenue left as operating profit after deducting the costs of running the core business.
- Cyclical StockA cyclical stock is one whose fortunes rise and fall with the broader economic cycle, booming in upturns and slumping in downturns.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.