V07: Gross margin — how to analyse it

Gross margin shows pricing power. High gross margin = the company can charge a high price (Apple, luxury goods). Low gross margin = sensitive to competition (component manufacturing).

This is V07 — Gross margin in the AKM1 model: one of the 20 variables that together determine whether a company is an institutional quality stock or a collection of stories. In this article you get the variable explained, how to compute it yourself, and how three of history's greatest investors would have interpreted it.

Why the variable exists

Gross margin as a concept is ancient — merchants in ancient Babylon and Renaissance Venice computed 'profit after cost of goods' as a basis for business decisions. Double-entry bookkeeping (Luca Pacioli, 1494) formalised in accounting the separation of cost of goods from operating cost in the income statement. In the 1800s, with the industrial revolution, gross margin began to be used systematically in business analysis — Carnegie's steel works computed 'margin on steel sold' as a key metric. But it was only in the 1920s, with Benjamin Graham and David Dodd's 'Security Analysis' (1934), that gross margin was established as a formal investment indicator.

The core of gross margin

What gross margin really measures Gross margin is the first profitability indicator in the income statement — it shows how much remains of every krona of revenue after the company has paid for what was sold. The formula is elegant in its simplicity: (Net revenue − Cost of goods sold) / Net revenue. But behind this line hides the company's business model in pure form. A company with an 80% gross margin sells something that costs almost nothing to produce — software, licences, digital services. A company with a 15% gross margin sells something where the cost of goods eats almost everything — raw materials, distributed goods, commodity manufacturing. The gross margin is thus not just a number — it is a diagnosis of what the company does. Atlas Copco has a gross margin of ~38% (compressors with a high technical moat + service), H&M ~52% (clothes with a brand premium), AstraZeneca ~80% (pharmaceuticals with patents). The same variable, three entirely different business models — all mutually incomparable in absolute terms.

Computing gross margin in practice

Find the numbers in the annual report Gross margin requires two lines from the income statement: Net revenue and Cost of goods sold (KSV). In a Swedish annual report under K3 or IFRS you find net revenue on line 1 in the income statement. KSV can have different names: 'Cost of goods sold', 'Raw materials and consumables', 'Costs for goods sold', or — especially for service companies — 'Costs for delivered services'. Some companies report 'Gross profit' directly — then gross margin = Gross profit / Net revenue × 100. Example AstraZeneca 2023: Net revenue 45 811 MUSD, Cost of goods sold 9 093 MUSD → Gross profit 36 718 MUSD → Gross margin = 36 718/45 811 × 100 = 80,1%. This gives score 5 (>75%) on the AKM1 scale — typical for patent-protected pharmaceuticals.

The dark side of gross margin — traps and illusions

One-off items in KSV Cost of goods sold can contain one-off items that distort the gross margin. Common cases: 1) Inventory impairments — when the company writes down the value of old inventory (fashion that did not sell, components that have become obsolete) this is booked as extra KSV, which lowers the gross margin. If the company has a 'normalised' gross margin without these items, it is higher. 2) Restructuring costs in production — when the company closes a factory, one-off costs can be booked in KSV. 3) Currency effects on the cost of goods — a Swedish company that imports components from Asia and sells in SEK can see the gross margin fall when SEK weakens. This is not operational — it is a currency effect that should be adjusted away.

Three perspectives on gross margin

Peter Lynch: Lynch loved a high gross margin. In 'One Up On Wall Street' he argued that a gross margin >50% indicates a company with pricing power — 'they can raise the price without losing customers'. He compared gross margins within the industry: 'If everyone else has 20% and this company has 60%, they have a moat.'

Benjamin Graham: Graham saw gross margin as an indicator of competitiveness. He argued that a stable high gross margin over 10+ years indicates a durable moat. Graham's rule: 'Gross margin should be stable or increasing over business cycles.' A falling gross margin = warning.

AK1's interpretation: AKM1 weight 6%. Gross margin is the purest indicator of pricing power. We assess gross margin in three ways: (1) level — >60% excellent, 30-60% good, <30% weak, (2) trend — stable/increasing good, falling warning, (3) industry comparison — high vs industry = moat. AKM1 combines V07 with V14 (brand) — a high gross margin without a brand is suspicious.

Go deeper

From measuring gross margin to predicting compounding

Want to practise with worked examples, chapter by chapter? The course Gross margin (V07) contains 6 chapters, Lynch and Graham perspectives and how AK1 uses the variable in the wave matrix. See also the complete guide to Swedish stock analysis for how all 20 variables fit together.

FAQ

What is gross margin?

Gross margin shows how much remains of every revenue krona after the company has paid for what it sold. The formula is (net sales − cost of goods sold) ÷ net sales. The margin is the first profitability line in the income statement and works as a diagnosis of the business model — software and pharmaceuticals often exceed 70 percent, while distribution and raw-material handling are far lower. The course Bruttomarginal (V07) practises the method chapter by chapter.

Where do I find the figures in the annual report?

You need two lines: net sales (the first line of the income statement) and cost of goods sold, which may be called ‘Raw materials and consumables’ or ‘Costs for services delivered’. Some companies report gross profit directly — then it is enough to divide gross profit by net sales. The article above shows a worked example of how the calculation is done.

What does it mean when gross margin falls?

En fallande bruttomarginal kan bero på svagare prissättningsmakt eller ökade varukostnader, men också på engångsposter som lager nedskrivningar eller valutaeffekter. Metoden är att först ta reda på orsaken: är fallet operationellt eller en bokföringseffekt? En stabil eller stigande marginal över en hel konjunkturcykel anses däremot tyda på en varaktigare konkurrensfördel.

Can gross margin be compared across industries?

No, not in absolute terms. A pharmaceutical company at 80 percent and a retailer at 20 percent have completely different business models — within their respective industries both levels can be strong. The method is to compare the company against its industry peers and against its own history over time; it is the relative levels and trends that carry the information.

This is educational financial analysis, not investment advice.