Introduction
In its fiscal year to August 2026, Costco earned an operating margin of 3.9%. Microsoft, in its fiscal year to June 2026, earned 46.8%. Both are among the most successful companies in the world, and neither margin is a sign of strength or weakness on its own. Costco sells goods at close to cost and makes about half of its operating income, $5.9 billion of $11.7 billion, from the membership fees its customers pay to shop there, according to its 2026 annual report. Microsoft sells software and cloud services whose extra copies cost little to deliver. The margins describe two business models before they describe two levels of performance.
Margins are the most used and most misused ratios in financial analysis. They are simple to calculate, they compress a whole income statement into a few percentages, and they invite comparisons that the underlying businesses do not support. Using them well means knowing what each one measures and what drives it.
The Margin Hierarchy
Each margin divides a level of profit by revenue, and each level answers a different question. Gross margin, revenue less the cost of goods or services sold, shows how much a company earns on what it sells before the costs of running the business. Operating margin, after selling, general, administrative and research costs, shows the profitability of the whole operation. EBITDA margin, based on earnings before interest, taxes, depreciation and amortization, adds back depreciation and amortization to show operating profit before the non-cash cost of past investment. Pre-tax and net margins bring in interest, other income and taxes, and so reflect financing and tax structure as well as operations. The building blocks are explained in cost of goods sold and gross profit and operating income and EBITDA.
The largest companies show how wide the range is:
| Company and year end | Gross margin | Operating margin | Net margin |
|---|---|---|---|
| Microsoft, June 2026 | 67.9% | 46.8% | 40.3% |
| Apple, September 2025 | 46.9% | 32.0% | 26.9% |
| Home Depot, February 2026 | 33.3% | 12.7% | 8.6% |
| Costco, August 2026 | 11.1% | 3.9% | 3.0% |
Costco's gross margin is shown on net sales, excluding membership fees; its operating and net margins include them. Each figure comes from the company's latest annual report, and each reflects choices about what goes into cost of sales, a point that matters as soon as the comparison moves beyond broad differences of business model.
What Drives Margins
Business Model and Asset Turnover
Low margins are not a problem if the assets turn over fast. Costco's warehouses sell a limited range of goods in bulk, with inventory that sells through quickly and memberships that are paid in advance. Each dollar of assets generates several dollars of sales, a high asset turnover, so a thin margin still produces a strong return on capital. A software company with high margins may need little capital at all; a capital-intensive manufacturer with similar margins may need much more. Margin is one of the three parts of return on equity in DuPont analysis, and judging it without turnover gives half the picture.
Mix
When a company sells products with different margins, its overall margin moves with the sales mix even if no individual margin changes. Apple's products earned a gross margin of 36.8% in its 2025 fiscal year and its services 75.4%, according to its 2025 annual report. Apple's total gross margin has risen from 44.1% to 46.9% over two years, and about half of that rise comes from mix alone, as services grew from 22% to 26% of sales; the rest comes mostly from a wider services margin. Mix effects are common across industries: a retailer selling more groceries and fewer appliances, a bank earning more from fees than from lending, or a manufacturer selling more aftermarket parts relative to new equipment.
Pricing, Costs and Investment
Pricing power, input costs and investment cycles move margins within a given mix. Microsoft's gross margin edged down from 68.8% to 67.9% in its 2026 fiscal year, which the company attributes to continued investment in artificial intelligence (AI) infrastructure and growing AI product usage, partly offset by efficiency gains, as its 2026 annual report explains. Its operating margin rose at the same time, from 45.6% to 46.8%, because operating expenses grew more slowly than revenue. A gross margin that falls while operating margin rises is a pattern worth noticing: each sale costs more to deliver, but operating expenses are spread over revenue that is growing much faster, and the analysis turns on which of the two effects will last.
Operating Leverage
Fixed costs make margins sensitive to volume. When revenue rises faster than costs that do not vary with it, operating margins expand; when revenue falls, they contract quickly. Incremental margins measure the effect.
- Incremental margin
The change in a level of profit divided by the change in revenue between two periods. An incremental operating margin above the average operating margin means profits are growing faster than revenue, a sign of operating leverage; one below it means new revenue is less profitable than the existing business.
Microsoft's revenue grew by $50.1 billion in its 2026 fiscal year and its operating income by $26.7 billion, an incremental operating margin of about 53%, above its average. Costco's revenue grew by $27.9 billion and its operating income by $1.3 billion, an incremental margin of about 4.7%, also above its average of 3.9%. Both were expanding margins, from very different starting points.
Comparing Margins Across Companies
Margins are only comparable when companies classify costs the same way, and often they do not. The most common differences are these:
- Retailers differ in whether buying, occupancy and distribution costs sit in cost of sales or in selling and administrative expenses, which can move gross margin by several percentage points without changing operating margin.
- Some companies include depreciation in cost of sales and others report it separately, so gross margins differ while EBITDA margins do not.
- Companies acting as agents report revenue net of what they pass to suppliers, which raises their margins relative to those that report gross.
- Stock-based compensation is included in reported costs but excluded from most adjusted margins.
Many retailers warn in their accounting policies that their gross margin may not be comparable with others' for exactly the first reason. The revenue question is covered in gross vs net revenue.
Net margin needs the most care. Microsoft's net margin of 40.3% included $5.0 billion of after-tax gains on its investment in OpenAI, which it excludes from its adjusted net income; without them, the margin would have been about 38.8%. Interest, investment gains and losses, tax rates and one-off items all reach net income, so two businesses with identical operations can report very different net margins. For comparing operations, operating or EBITDA margin is usually the better measure.
How Bankers Use Margins
In valuation, margins explain why companies with similar growth trade at different multiples of revenue. A business with a 40% EBITDA margin converts each dollar of revenue into far more cash flow than one with 10%, so it deserves a higher revenue multiple, which is why bankers usually compare companies on multiples of EBITDA or earnings instead. In forecasting, margin assumptions are often the single most important driver of a model's output, and the case for a deal, whether a buyout or a strategic acquisition, frequently rests on margin expansion through cost savings, pricing or mix.
The best margin analysis explains movements rather than reporting them. For each change in a company's margins, the questions are what caused it, whether it will persist and what it implies for the company's competitive position. A margin that has expanded because of a temporary drop in input costs is worth less than one that has expanded because of a durable shift in mix; the sequence in how bankers analyze financial statements puts those questions in context with growth, cash conversion and returns.
