Why Positive and Expanding Operating Income Is a Core Indicator of Business Quality
- Max Teh
- 3 days ago
- 3 min read
Updated: 1 day ago
KEYPOINTS
🔑 Positive and growing EBIT signals a business model that is working and scaling effectively.
🔑 Expanding operating margins reflect pricing power, cost discipline, and operating leverage.
🔑 Companies with improving EBIT and OPM% tend to see stronger valuation support and lower risk of de-rating.
Table of contents
Disclaimer: This communication is provided for information purposes only and is not intended as a recommendation or a solicitation to buy, sell or hold any investment product. Readers are solely responsible for their own investment decisions.
When analysing a company’s financials, one of the most important checkpoints is this:
Is the company generating operating profits and are those profits improving over time?
Operating Income (EBIT) reflects the profitability of the company’s core business, before the effects of financing and accounting adjustments. In other words, it tells you whether the business model itself is fundamentally working.
What Trends Investors Should Look For in Companies' Operating Income
1) Positive & Growing Operating Income (EBIT)
Ideally, the company should already be:
Profitable at the operating level, and
Showing a consistent upward trend in Operating Income
For more established companies, a good benchmark is having positive EBIT over the past ~5 years.
For newer or recently listed companies, a shorter track record is acceptable, but the key is whether the business is clearly moving towards sustained profitability, rather than remaining structurally loss-making.
Stronger signal if:
Operating Income is growing at ≥20% annually
2) Improving (or Strong) Operating Margin (OPM%)
For companies that have already achieved operating profitability:
Operating Margin should ideally be consistently ≥30%
At the very least, margins should be stable or improving over time
This reflects:
Pricing power
Cost discipline
Operating leverage as the business scales
Why This Matters
Companies with positive and improving EBIT + OPM% tend to exhibit several favourable characteristics:
Valuation Tailwinds: As EBIT grows, valuation metrics like EV/EBIT naturally compress, even without multiple expansion
Improving Financial Health: Higher operating profits strengthen interest coverage, especially for companies with net debt
Stronger Market Confidence: Consistent profitability builds investor trust and reduces the risk of valuation de-rating over time
How to Interpret Different Situations
✅ Companies with Strong Signal
EBIT is positive
EBIT is growing
Operating Margins are stable or expanding
These are typically high-quality businesses with scalable models.
Examples:
Microsoft
Qualys
TSMC
👀 Companies at Inflection Point (Worth Monitoring Closely)
EBIT just turned positive recently
But trends show clear improvement towards profitability
Margins are improving
These companies may be approaching state of sustainable profitability on Opearting Income level which can be an important turning point.
Example: Dave
❌ Companies with Red Flag with no EBIT profitability in sight.
EBIT remains negative after many years of operation (e.g. ~10 years)
No meaningful improvement in margins
Over time, this tends to lead to:
Investor fatigue
Valuation de-rating
Example: Atlassian
Final Thoughts
A company that has been operating for many years but still struggles to achieve operating profitability raises valid concerns about the sustainability of its business model.
On the other hand, companies with positive, growing EBIT and improving margins are often:
More resilient
Easier to value
Better positioned to compound returns over the long term
If you are constructing a long-term portfolio, this is not just a good-to-have metric it should be one of the core filters.
This is just one of the many checklists I use to analyse stocks and construct my portfolio.
If you’re interested in the full framework, 👉 click here to explore all my checklists
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