Lesson 2 of 7
Operating leverage, measured
A filed year in which operating income fell by more than revenue did. The computation, the ratio the product stores, and why the sign flips on a loss.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Operating leverage is the percentage change in operating income divided by the percentage change in revenue, and the product stores it as one figure.
- At a capital-intensive filer in one filed pair of years, operating income fell by more in dollars than revenue did.
- The ratio is unstable near a zero denominator and meaningless across a sign change, so it is read alongside the two underlying movements and never alone.
The previous lesson gave a ratio of capital intensity. This one gives the consequence, computed from two adjacent filed years at one company.
Revenue and operating income at one filer, four filed fiscal years
- Revenue
- Operating income
Show the numbers
| Revenue | Operating income | |
|---|---|---|
| FY22 | 30,758$m | 9,702$m |
| FY23 | 15,540$m | −5,745$m |
| FY24 | 25,111$m | 1,304$m |
| FY25 | 37,378$m | 9,770$m |
The computation
Operating leverage as ValueScreener stores it is the percentage change in operating income divided by the percentage change in revenue, year on year. Two lines from the income statement, one number.
Above one, profit moves proportionally more than sales. Below one, less. Negative, the two moved in opposite directions.
The year itself
Between the fiscal year ended 1 September 2022 and the fiscal year ended 31 August 2023, at the filer above: revenue fell from 30,758 million dollars to 15,540 million, a fall of 15,218 million or 49.5 percent. Operating income fell from a profit of 9,702 million to a loss of 5,745 million, a fall of 15,447 million.
So the operating line fell by 15,447 million on a revenue fall of 15,218 million. A dollar of lost revenue took slightly more than a dollar of operating profit with it: 1.015 dollars, to be exact about a figure that does not deserve three decimals.
That is what it looks like when almost none of the cost base goes away.
Why the stored ratio does not help in that particular year
Because the operating line crossed zero. A percentage change from a profit to a loss is an arithmetic artefact: the denominator of the percentage is a positive number and the numerator spans a sign change, so the result carries no useful scale.
The product stores 13.29 for this filer's most recent filed year, where operating income went from 1,304 million to 9,770 million while revenue went from 25,111 million to 37,378 million. Both moved in the same direction and neither crossed zero, so the ratio means what it says: profit moved about thirteen times as far, proportionally, as sales did.
What to do with it
Use it as a flag rather than as a measure. A filer whose operating leverage reads far from one in several consecutive years is a filer whose profit is a geared version of its sales, and that is worth knowing before writing any condition on a margin.
Then go back to the two underlying movements and read them directly, because they are stable, they are in dollars, and they do not misbehave near zero.
Check yourself
Revenue fell by 15,218 million and operating income fell by 15,447 million. What does that say about the cost base?
- That costs rose during the year
- That almost none of the cost base fell with revenue, since a dollar of lost sales took slightly more than a dollar of operating profit
- That the company took an impairment
Show the answer
Answer: B.
An impairment would be one explanation for costs not falling; a depreciation charge on a plant already built is another, and it is the subject of the sixth lesson.Why is the stored operating leverage ratio unusable across a move from profit to loss?
- Because the product does not compute it in loss years
- Because the numerator spans a sign change, so the resulting percentage carries no useful scale
- Because revenue also changed
Show the answer
Answer: B.
The ratio is also unstable when revenue barely moves, which is how one filer above produced a reading of negative 14.16 on a 1.11 percent revenue change.What does a reading of negative 14.16 mean?
- That operating income fell fourteen times faster than revenue
- That the two lines moved in opposite directions, and that the denominator was small enough to make the magnitude unreliable
- That the company is highly capital intensive
Show the answer
Answer: B.
Revenue rose 1.11 percent while operating income fell 15.66 percent. The sign carries the information; the magnitude is an artefact of the small denominator.Sources
- Micron Technology, Inc., annual reports on Form 10-K for fiscal years 2022 through 2025, for revenue and operating income: fiscal 2022 accession 0000723125-22-000048; fiscal 2023 accession 0000723125-23-000054; fiscal 2024 accession 0000723125-24-000027; fiscal 2025 accession 0000723125-25-000028.
- Toll Brothers, Inc., annual reports on Form 10-K for the fiscal years ended 31 October 2024, accession 0000794170-24-000051, and 31 October 2025, accession 0000794170-25-000112.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- Operating leverage as computed here is a one-year-on-one-year ratio. It is unstable when the denominator is near zero and undefined in meaning when the numerator crosses a sign change, and both cases appear above.
- One pair of years at one company is an illustration of a measurement, not evidence about how any business behaves in general.
- Nothing here is a view on either company or on any security.