After-Tax Corporate Profits Chart 2nd Quarter 2013

Today’s GDP release (Q2, 2nd Estimate) was accompanied by the BLS Corporate Profits (preliminary estimate) report for the 2nd Quarter.

Of course, there are many ways to adjust and depict overall Corporate Profits.  For reference purposes, here is a chart from the St. Louis Federal Reserve (FRED) showing the Corporate Profits After Tax (last updated August 29,2013, with a value of $1830.4 Billion) :

CP_8-29-13 1830.4

Here is the Corporate Profits After Tax measure shown on a Percentage Change from a Year Ago perspective:

CP_8-29-13 1830.4 Percent Change From Year Ago

Data Source: FRED, Federal Reserve Economic Data, Federal Reserve Bank of St. Louis: Corporate Profits After Tax [CP]; U.S. Department of Commerce: Bureau of Economic Analysis; accessed August 29, 2013; https://research.stlouisfed.org/fred2/series/CP

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StratX, LLC (stratxllc.com) is a management consulting firm and strategic advisory that focuses on the analysis of current and future business conditions, and offers corporations and businesses advice, strategies, and actionable methods on how to optimally increase revenues and profitability.

The Sustainability Of Profit Margins

The topic of corporate earnings growth and its sustainability, given a variety of metrics, has been discussed in various posts in this blog.

The Wall Street Journal article of August 24-25, 2013, titled “Lofty Profit Margins Hint at Pain to Come for U.S. Shares,” discusses various facets of whether corporate profit margins are likely to be sustained.  As well, corporate profit margins and fluctuations are discussed from a long-term historical perspective.

While the article contains various noteworthy comments, here is one excerpt:

U.S. corporations, on average, currently report a profit of 9.3 cents for every dollar of sales, according to U.S. Commerce Department data—a profit margin of 9.3%. It has gotten only slightly higher than this over the past six decades: In the fourth quarter of 2011, it was 10%. The average since 1952 is 5.9%.

Profit margins in the past have exhibited a strong historical tendency to “revert to the mean,” according to James Montier, a visiting fellow at the U.K.’s University of Durham and a member of the asset-allocation team at Boston-based GMO, an investment firm with $108 billion under management. That is, above-average levels in the past have tended to quickly fall, just as below-average levels in the past have soon risen.

Consider all occasions since the early 1950s in which the profit margin rose to at least 6.9% or fell to at least 4.9%—one percentage point away from its historical mean, in other words. On average, it was back at its mean in just 4.8 years.

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StratX, LLC offers the above commentary for informational purposes only, and does not necessarily agree with the views expressed by these outside parties.

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StratX, LLC (stratxllc.com) is a management consulting firm and strategic advisory that focuses on the analysis of current and future business conditions, and offers corporations and businesses advice, strategies, and actionable methods on how to optimally increase revenues and profitability.

Impact Of Low Interest Rates On Corporate Profitability

In the last post (“Headwinds Facing Future Corporate Profitability“) one of the factors I discussed was the impact that rising interest rates have had on corporate profitability.

As I indicated in that post, I believe there are various impacts, both “direct” and “indirect,” that low interest rates have had on corporate earnings.  Two recent article discuss what (I consider “direct”) impact low interest rates have had on overall corporate profitability, as depicted by S&P500 earnings.

The first is seen in the Wall Street Journal of July 23 and is titled “Fed Plays Part at the (Profit) Margins.”  This artice discusses the impact of low interest rates on S&P500 margins.  Two excerpts from the article:

But an analysis conducted by independent strategist Brett Gallagher shows that low interest rates have done much to bolster margins. Given the superlow interest-rate era may soon start drawing to a close, that could be another reason for investors to question just how long margins can hold up.

also:

The lower rates have helped companies substantially lower their interest-rate costs. Mr. Gallagher found that in 2012, interest expenses—what companies had to pay to service their debt—came to 1.8% of sales for companies in the S&P 500. That compares with a 15-year average of 3.9%. Nor does this reduction in interest expense reflect a reduction in debt: Net debt as a percentage of assets stood at 14.2%, above the 15-year average of 11.5%.

Another article that discusses the impact that interest rates have had on corporate earnings is a Reuters article seen in the Chicago Tribune article of July 25 titled “Analysis:  How much is Fed aid to U.S. corporate profits worth?” An excerpt from this article:

The Fed’s effect on corporate earnings is difficult to quantify. Van Batenburg estimates that corporate savings on interest expense after rates fell to historic lows has accounted for about 47 percent of S&P 500 earnings growth since 2009.

At the end of 2009, quarterly earnings per share for the S&P 500 were less than $20, and companies in the index paid about $4 a share in interest, van Batenburg said. Now the S&P 500 is generating about $26.70 a share in quarterly earnings but pays just $1.50 a share in interest.

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StratX, LLC offers the above commentary for informational purposes only, and does not necessarily agree with all (or any) of the views expressed by these outside parties.

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StratX, LLC (stratxllc.com) is a management consulting firm and strategic advisory that focuses on the analysis of current and future business conditions, and offers corporations and businesses advice, strategies, and actionable methods on how to optimally increase revenues and profitability.

Headwinds Facing Future Corporate Profitability

Corporate earnings and earnings growth is a particularly notable subject at this time. As I wrote in the blog post of June 11, 2013 (“The Current High Levels Of Corporate Profitability“) current various levels of profitability – including the S&P500′s operating margins, operating profits, EPS, and After-Tax Corporate Profits as a Percentage of GDP – are at or near record-high levels.  Furthermore, as seen in a variety of aggregate S&P500 earnings forecasts, S&P500 EPS growth for years 2013-2015 is projected to be fairly robust.

I believe that for a variety of reasons, on a going-forward basis earnings face a variety of “headwinds’ that will prove substantial.  My analyses indicate that many of these “headwinds” lack proper recognition. Here are some of the  factors that I consider significant:

The threat of deflation

I’ve discussed the threat of deflation in a variety of recent blog posts, including the July 11, 2013 post titled “Would Deflation Be Beneficial?” as well as the June 10, 2013 post “The Prospect Of Deflation.”  While none of the recent various business surveys (or economist surveys) indicate that businesses expect oncoming deflationary conditions, whether businesses would foresee – and successfully adapt – to such deflationary conditions remains to be seen. It appears as if businesses aren’t assessing and/or planning for a deflationary environment.  Should deflationary conditions occur – and I believe deflationary conditions are on the horizon – the impact on businesses’ revenues and profitability would likely (depending upon the extent of the deflation as well as other factors) be pronounced.  Deflationary conditions, along with likely accompanying significant declines in aggregate demand, would likely highly impact revenues and profitability.

Ongoing weak revenue growth

Persistent weak revenue growth – and even revenue declines among various companies – has been an ongoing problematical characteristic since 2009.  While this overall weakness in revenue growth has coincided with substantial aggregate growth in profitability,  this weakness in revenue growth is cause for concern on many fronts.

Rising Interest Rates

While the recent increases in interest rates impacts companies differently depending upon many factors, from a general perspective this increase has many direct and indirect impacts on profitability.  While the direct impacts include such issues as borrowing costs, perhaps the greater issue is what impact increases in interest rates will have on overall demand.  While of course the overall impact of rising interest rates on profitability will depend upon the extent of the interest rate increase, even an increase in interest rates to (historically) “normal” levels would likely have a significant – if not substantial – impact on overall business profitability.  A chart of 10-Year Treasury Yield, from Doug Short’s monthly update, is seen below and gives one perspective as to how low today’s interest rates have fallen:

Dshort 7-12-13 10-year-yields-since-1965-log-scale

Widespread Weak(ening) Economic Growth 

While economists continue to predict 2013 GDP will come in above 2.0%, there appears to be a growing consensus that 2nd quarter GDP will be (at most) 1%.  International economic growth, in many instances, is also predicted to be weak or weakening.  Of course, actual GDP growth can come in above or below these forecasts, but for a variety of reasons I believe that even these GDP forecasts will prove overly optimistic.

Other factors

There are many other factors that have positively impacted profitability, some of which I mention in the above-referenced June 11 blog post.  Also in that blog post, one can see how “stretched” overall profitability is to GDP from a long-term perspective.  One critical question is whether such historically high levels of profitability represent a new structural era in which such high levels are sustainable, or whether such outsized profitability is anomalous and will (at minimum) mean-revert.    I strongly believe that, from an all-things-considered basis, the latter will prove true, which will have an outsized negative impact on profitability.

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StratX, LLC (stratxllc.com) is a management consulting firm and strategic advisory that focuses on the analysis of current and future business conditions, and offers corporations and businesses advice, strategies, and actionable methods on how to optimally increase revenues and profitability.

S&P500 Historical And Projected Net Profit Margins

For reference purposes, below are two charts depicting net profit margins for the S&P500.  Both charts are from the FactSet Earnings Insight report (pdf) dated July 12, 2013.

The first chart depicts S&P500 net margins (TTM) since mid-2003, as depicted:

Trailing 12M Net Margin: 10 Years

FactSet Earnings Insight 7-12-13 - SPX Trailing 12M Net Margin - 10 Years

The second chart depicts S&P500 quarterly net margins from Q4 2010 through Q1 2013, and projected net margins from Q2 2013, as depicted:

Quarterly Net Margins (Bottom-Up EPS / Bottom-Up SPS)

FactSet Earnings Insight 7-12-13 - SPX Quarterly Net Margins

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StratX, LLC offers the above data and projections for informational purposes only, and does not necessarily agree with information provided by these outside parties.

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StratX, LLC (stratxllc.com) is a management consulting firm and strategic advisory that focuses on the analysis of current and future business conditions, and offers corporations and businesses advice, strategies, and actionable methods on how to optimally increase revenues and profitability.