There are two types of leverage in investing – operating and financial leverage. We have discussed financial leverage to a great extent in previous articles, hence we shall not touch on this but rather focus our efforts on explaining operating leverage using a investment case study: Netflix.

What is Operating Leverage?

The thing that differentiates it from financial leverage, would be operating leverage has a larger percentage of fixed expenses. High operating leverage means most costs are fixed. Companies with high operating leverage would essentially mean that a 1% increase in revenue would lead to a greater than 1%, say 5% increase in net earnings. This is because they do not have to increase costs proportionately to generate a 1% increase in revenues.

However, with any form of leverage, while on the upside it magnifies profits, it too will magnify losses on the downside. Hence, any small error in forecasting sales revenue growth ...