By Antonios Fotakis | July 2026
A note before you read: Gross-Margin is the first profitability number that matters – because it tells you whether the core product or service a company sells is actually profitable before any other cost enters the picture. A business can fix its overheads, cut its marketing, restructure its debt. It cannot easily fix a broken gross margin. This article explains why.
What is gross margin. Let me ask you something.
Imagine you bake and sell artisan bread. Each loaf sells for €5.
The flour, yeast, water, packaging, and the energy to bake it cost you €1.50 per loaf.
That leaves €3.50 per loaf before you’ve paid for rent, staff, marketing, or anything else.
That €3.50 – the money left after the direct cost of making the product – is your gross profit.
Expressed as a percentage of the selling price, it’s your gross margin: 70%.
Now imagine a competitor sells the same loaf for €5 but their ingredients and production costs are €4 per loaf.
Their gross margin is just 20%.
Both businesses are selling bread at the same price.
But the first has €3.50 per loaf to cover its overhead costs and generate profit.
The second has only €1 per loaf to work with.
The first can absorb a rent increase, hire more staff, or invest in marketing without collapsing.
The second is already operating on a knife’s edge.
Gross-Margin is the foundation. Everything else in the business is built on top of it.
So What is Gross Margin, Exactly?
Gross-Margin is the percentage of revenue that remains after subtracting the direct costs of producing goods or services – before any operating expenses, interest, or taxes are deducted.
The formula: Gross-Margin = (Revenue − Cost of Goods Sold) ÷ Revenue × 100
Revenue is the total money the company received from selling its products or services.
Cost of Goods Sold (COGS) – sometimes called Cost of Revenue – is the direct cost of producing whatever was sold. This includes raw materials, direct manufacturing labour, packaging, and any other costs that scale directly with production volume. It does not include rent, management salaries, marketing, R&D, or any other overhead cost.
The difference between Revenue and COGS is Gross Profit. Expressed as a percentage of Revenue, it becomes the Gross Margin.
If a company generates €100 million in revenue and its direct production costs are €40 million, the gross profit is €60 million and the gross margin is 60%.
Gross-Margin answers the most fundamental question in business: how profitable is the product itself, before the rest of the organisation gets involved?
Why Gross Margin is the Most Important of the Three Margin Metrics
In the Profit Margin article, we introduced three layers of profitability – gross, operating, and net. Each tells you something different. But gross margin is the foundation that determines the ceiling for everything else.
Here’s why.
Operating expenses – salaries, rent, marketing, R&D – can be reduced, restructured, or optimised. A company with high operating costs but strong gross margins has options: cut overhead, find efficiencies, scale to spread fixed costs across more revenue. The path to profitability is visible.
A company with weak gross margins has a much more fundamental problem. No amount of cost-cutting in overhead will fix a product that costs nearly as much to make as it sells for. The unit economics – the profitability of each individual sale – are broken at the source. And unit economics, unlike overhead structures, are very difficult to improve without fundamentally changing what you make or how you make it.
A business with a 70% gross-margin and high overhead costs is a business that needs operational discipline. A business with a 15% gross-margin is a business with a structural problem.
This is why gross margin is often the first number serious investors look at when evaluating any company – because it tells them whether the core business model is fundamentally sound before they even look at anything else.
What is a Good Gross Margin?
Gross-Margin varies enormously by industry – and comparing across sectors is almost meaningless. What matters is how a company’s gross margin compares to its direct competitors and to its own history over time.
| Industry | Typical Gross-Margin Range |
|---|---|
| Software / SaaS | 65% – 85% |
| Pharmaceuticals | 60% – 80% |
| Financial services | 50% – 75% |
| Consumer brands | 40% – 65% |
| Industrial / Manufacturing | 25% – 45% |
| Retail | 20% – 40% |
| Grocery / Supermarkets | 20% – 30% |
| Restaurants | 55% – 75% (food cost only) |
| Construction | 15% – 30% |
Software companies have extraordinarily high gross margins because the cost of delivering one additional unit of software to a new customer is almost zero – no raw materials, no manufacturing, no physical delivery. Once the software is built, the marginal cost of each additional sale approaches nothing.
Supermarkets have very low gross margins because they are selling physical goods at thin markups over what they paid for them – their model depends entirely on volume and operational efficiency rather than product-level profitability.
A 25% gross-margin is not inherently bad – it might be outstanding for a construction company. The same margin in a software company would be a serious structural concern.
Gross Margin as a Signal of Competitive Advantage
Here is the insight that connects gross margin to the concept of competitive moat – and explains why some companies can sustain high gross margins while others cannot.
In a genuinely competitive market, high gross margins attract competition. If a product sells for €100 and costs €20 to make, competitors will enter the market, compete on price, and drive margins down toward a more sustainable level. That’s how competitive markets work.
So when a company sustains high gross margins over many years – despite competition, despite cost pressures, despite economic cycles – something is protecting those margins. A brand premium that allows higher pricing. Proprietary technology that competitors cannot replicate. A manufacturing process so efficient that the cost advantage cannot be matched. Customer switching costs that allow pricing above the competitive minimum.
Sustained high gross margins are therefore one of the earliest financial fingerprints of competitive advantage – visible before it shows up in RoIC or in qualitative analysis of the business model.
A company that has maintained a 70%+ gross margin for ten years in a competitive industry is being protected by something. Finding out what that something is will tell you more about the investment than almost any other piece of research.
Conversely, a declining gross margin trend – even from a high starting level – is one of the earliest warning signs of competitive pressure. If a company’s gross margin has been declining consistently for several years, competition is winning on price or cost, and the structural advantage may be eroding.
Gross Margin vs Net Margin – The Gap Between Them
Understanding gross margin alongside net profit margin gives you a very specific and useful picture of where a company’s costs are concentrated.
Large gap between gross-margin and net-margin: The company’s direct production costs are well-managed, but significant costs exist in the overhead structure – sales and marketing, R&D, administrative costs, debt service. This is typical of growth-phase companies investing heavily in expansion, and is completely acceptable when the gross margin is strong and the overhead investment is creating future value.
Small gap between gross-margin and net-margin: The company runs lean – overhead costs are minimal relative to gross profit. This is typical of mature, highly efficient businesses that have already scaled past the heavy investment phase.
Low gross-margin with any gap at all: The product is barely profitable at the unit level, and any overhead costs push the business into losses quickly. This is the most structurally fragile position – the company has limited room to invest in growth, absorb cost increases, or weather revenue downturns.
| Gross-Margin | Net-Margin | What It Generally Suggests |
|---|---|---|
| 70% | 20% | Strong unit economics, healthy overhead – mature profitable business |
| 70% | 2% | Strong unit economics, heavy overhead – likely investing aggressively in growth |
| 70% | -15% | Strong unit economics, very high overhead – early-stage growth company |
| 25% | 8% | Thin unit economics, lean overhead – mature, volume-dependent business |
| 25% | -5% | Thin unit economics, moderate overhead – structurally challenged |
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Gross Margin and the Path to Profitability
For growth companies that are currently unprofitable, gross margin is the single most important metric for evaluating whether profitability is eventually achievable – and on what timeline.
A company with 75% gross margins and negative net margins is spending heavily on sales, marketing, and R&D to grow. As revenue scales, the overhead costs – which are largely fixed or semi-fixed – become a smaller and smaller percentage of revenue. At some point, the gross profit generated by each additional euro of revenue exceeds the marginal overhead cost of generating it. The company crosses into profitability – and because of the high gross margins, that profitability can improve very rapidly thereafter.
This is the financial logic behind many of the most successful growth stock investments: high gross margin businesses that were unprofitable during aggressive expansion phases but crossed into profitability as they scaled, generating enormous operating leverage.
A company with 20% gross margins in the same situation faces a very different path. Even if it scales revenue dramatically, the gross profit generated per euro of revenue is so limited that covering fixed overhead costs requires an enormous revenue base. The path to profitability is much longer and much harder – and if costs rise or revenue growth slows, the crossing point recedes further into the future.
Gross margin is the slope of the profitability hill. A steep slope means you climb fast once you start climbing. A shallow slope means it takes a very long run before you reach the top.
How Gross Margin Fits Into Our Three Categories
Gross-Margin plays a different role across the three AF Core Global philosophies – but it functions as a fundamental quality filter in all three.
In Fortress, we invest through broad ETFs and index funds – which automatically hold a blend of companies across different gross-margin profiles. The aggregate gross-margin of a broad market index reflects the overall health of corporate unit economics. When aggregate gross margins are expanding across the market, it’s generally a positive signal for long-term earnings growth.
In Cash Flow, gross-margin stability is a key supporting signal for dividend sustainability. A company with consistently high and stable gross-margins has the fundamental capacity to maintain and grow its dividend through economic cycles – because the profitability of its core product is resilient. A Cash Flow holding whose gross margins are declining deserves close attention – it may be the first sign of competitive pressure that will eventually affect the dividend.
In High Voltage, gross-margin is one of our primary evaluation criteria – often more important than net-margin for earlier-stage companies. When evaluating a growth company that is currently loss-making, we look first at gross margin to determine whether the underlying unit economics are sound. A High Voltage pick with 75%+ gross-margins and negative net margins due to heavy growth investment is a fundamentally different risk from one with 30% gross-margins and the same losses – because the first has a clear mathematical path to profitability at scale, and the second may not.
The product either makes money or it doesn’t. Gross margin tells you which.
Not blind trust. Informed choice.
What to Look For When You See Gross Margin on a Screener
When Gross-Margin appears in your research, work through this sequence:
How does it compare to sector peers? This is always the first question. Gross margin is only meaningful in sector context – always compare to direct competitors before drawing conclusions.
Is it stable, improving, or declining over time? The trend matters as much as the level. Stable or improving gross margins signal maintained or strengthening competitive position. Declining gross margins – even from a high level – signal competitive pressure, input cost increases, or pricing power erosion worth investigating.
What is the gap between gross margin and net margin? A large gap means significant overhead costs – understand what they’re being spent on and whether that spending is creating future value. A small gap means a lean, mature operation.
For unprofitable companies – does the gross margin support a path to profitability? Calculate roughly what revenue scale would be needed for gross profit to cover current overhead costs. Is that scale realistic given current growth rates?
Has gross margin expansion or contraction accompanied revenue growth? Growing revenue with expanding gross margins is the ideal – the business is becoming more efficient as it scales. Growing revenue with shrinking gross margins means costs are rising faster than revenue, which deserves a clear explanation.
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Nothing in this article constitutes financial advice. All content is for informational and educational purposes only. Always do your own research before making any investment decision.
