Please review my online lecture on operating leverage and the chapter 12 text ma

Question

Please review my online lecture on operating leverage and the chapter 12 text material on operating leverage.

A company with high operating leverage has a low percentage of variable costs to sales.   Assume, for example, that your firm has sales of 1 million dollars and variable costs of 100,000 dollars.  The variable costs are only 10 percent of the sales.  This is a very high operating leverage situation.

High operating leverage companies will see dramatic increases in earnings per share with very small increases in sales.  This is because of the operating leverage inherent in their operating structure.  When earnings per share rise quickly this drives stock prices up fast too.

Given all of the information above, what would happen to stock prices of a high operating leverage company if sales fall slightly?   How would this impact EPS and then stock price?

Explanation / Answer

If the stock prices of a high operating leverage company were to fall slightly then this would have a drastic effect on the EPS (Earning Per Share) since the operating leverage is such a big integral part of their structure. As stated the reverse would also be true, a small increase in sales would drastically increase the earning per share due to the company being a high leverage operating one.

Hope this helped, good luck.

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