What is the gross margin formula?

Gross Margin = (Revenue − Cost of Goods Sold) ÷ Revenue × 100. COGS includes direct costs: raw materials, manufacturing labour, and direct production overhead. It excludes operating expenses like marketing, R&D, and admin.

What is a good gross margin?

It varies enormously by sector. Software: 60–85%. Pharmaceuticals: 60–80%. Consumer brands: 40–60%. Retail: 20–40%. Grocery: 25–30%. Airlines/auto: 10–20%. The key is trend — is it stable or expanding? And how does it compare to direct competitors?

What is the difference between gross margin and net margin?

Gross margin deducts only cost of goods sold. Net margin deducts all expenses (COGS, operating expenses, interest, taxes). Gross margin tells you the core business economics; net margin tells you what's left after running the entire company. Both matter.

Why is gross margin so important for growth companies?

For a high-growth company losing money, gross margin predicts whether it can ever become profitable. A 75% gross margin business losing money due to heavy R&D and sales spending has a clear path to profitability as it scales — those fixed costs spread over growing revenue. A 20% gross margin business has no such path.

What Is Gross Margin? How to Use It to Evaluate Stocks

What is gross margin?

Gross margin is the percentage of revenue that remains after subtracting the cost of goods sold (COGS) — the direct costs of producing whatever the company sells. It measures how efficiently a company produces its product before accounting for operating expenses like salaries, marketing, and rent.

Gross Margin = (Revenue − COGS) ÷ Revenue × 100

Example: A company with $100M in revenue and $60M in COGS has a gross profit of $40M and a gross margin of 40%.

What counts as COGS?

COGS includes only direct costs tied to producing goods or services: raw materials, direct manufacturing labour, factory overhead, and for software — hosting costs and payment processing. It does NOT include sales, marketing, R&D, or admin expenses — those are operating expenses subtracted later.

Gross margin by industry

Software/SaaS: 70–85% — near-zero marginal cost per additional customer
Pharmaceuticals: 60–80% — high R&D costs but low manufacturing costs post-approval
Consumer brands: 40–60% — depends on brand premium and sourcing efficiency
Retail: 25–45% — high volume, lower margins
Grocery: 20–30% — commodity products, intense competition
Manufacturing: 15–35% — high raw material and labour costs
Airlines: 10–20% — fuel and labour dominate costs

Always compare gross margin within the same industry — a 30% gross margin is excellent for retail but poor for software.

Why gross margin signals competitive advantage

A high and stable gross margin is one of the clearest indicators of pricing power — the ability to charge premium prices without losing customers. When a company's gross margin is expanding over time, it typically signals scale benefits, mix shift toward higher-margin products, or genuine pricing power.

Gross margin vs operating margin vs net margin

Gross margin: Revenue minus direct production costs — shows production efficiency
Operating margin: Gross profit minus operating expenses (R&D, sales, admin) — shows overall business efficiency
Net margin: What remains after all expenses including taxes and interest — the bottom line

A company can have high gross margin but poor net margin if it spends aggressively on sales and R&D — common in early-stage SaaS.

Red flags in gross margin

Declining gross margin: Could signal rising input costs, pricing pressure, or mix shift toward lower-margin products
Gross margin much higher than peers: Investigate why — may reflect accounting differences or unsustainable pricing
Gross margin below 20%: Very thin — little buffer if costs rise or revenue falls

Gross margin is the starting point for understanding any business's economics. Before analysing P/E ratios or EPS growth, check gross margin — it tells you whether the underlying business has the structural profitability to ever become a great investment.