Category: Profitability

Each month the Philadelphia Fed releases the Business Outlook Survey, which contains a variety of information concerning business conditions.

As seen on the site:

The Business Outlook Survey is a monthly survey of manufacturers in the Third Federal Reserve District. Participants indicate the direction of change in overall business activity and in the various measures of activity at their plants: employment, working hours, new and unfilled orders, shipments, inventories, delivery times, prices paid, and prices received. The survey has been conducted each month since May 1968.

One component of this survey are diffusion indices for both “Prices Paid” and “Prices Received.” (for those unaware, this survey provides the following definition:  “Diffusion indexes represent the percentage indicating an increase minus the percentage indicating a decrease.”)

Doug Short provides a monthly blog post concerning the Philadelphia Fed’s Business Outlook Survey.  For reference purposes, here is a chart he has created that shows, from a long-term perspective, the “Prices Paid” and “Prices Received” diffusion indices (shown by the dots) and their 12-month moving averages (shown by the solid lines) :

(click on chart to enlarge image)

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The Atlanta Federal Reserve publishes a monthly report titled “Business Inflation Expectations” (BIE) that contains statistics from a survey of regional businesses’ views on various factors that impact profitability.  These factors include unit costs, unit cost expectations, sales levels, profit margins, and other factors.

As described on the site:

Approximately 300 panelists receive the survey each month. Panelists represent businesses of various sizes headquartered within the Sixth District, which encompasses Alabama, Florida, Georgia, and sections of Louisiana, Mississippi, and Tennessee. Panelists range from executives of large corporations to owner-operators of small businesses. The industry composition of the panel roughly reflects the makeup of the national economy. Nevertheless, survey responses are weighted by industry shares of national gross domestic product.

An excerpt from the BIE Survey of July 17 (pdf) (involving 209 firms) :

Firms also report that, compared to this time last year, their unit costs are up 1.8 percent. The improvement in sales levels noted by respondents in June have receded somewhat, with 50 percent now saying their current sales levels are at or above normal compared to 56 percent in June. Profit margins also declined slightly from the June reading, with 46 percent of firms stating that their margins are at or above normal, compared to 49 percent in June. 

Also, this month’s “special question” was with regard to how businesses would react – from a pricing perspective – to a 10% increase or 10% decrease in raw material costs.  The chart of the questions results can be seen below:

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As well, a July 16 blog post from the Atlanta Fed, titled “Commodity Prices and Inflation:  The Perspective of Firms,” discusses the findings.

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The Atlanta Federal Reserve publishes a monthly report titled “Business Inflation Expectations” (BIE) that contains statistics from a survey of regional businesses’ views on various factors that impact profitability.  These factors include unit cost expectations, sales, profit margins, and price change expectations.

As described on the site:

Approximately 300 panelists receive the survey each month. Panelists represent businesses of various sizes headquartered within the Sixth District, which encompasses Alabama, Florida, Georgia, and sections of Louisiana, Mississippi, and Tennessee. Panelists range from executives of large corporations to owner-operators of small businesses. The industry composition of the panel roughly reflects the makeup of the national economy. Nevertheless, survey responses are weighted by industry shares of national gross domestic product.

A couple of excerpts from the BIE Survey (involving 190 firms) of June 21 include:

Respondents indicate that, on average, they expect unit costs to rise 1.8 percent over the next 12 months, roughly in line with the recent year-ahead inflation forecasts of private economists.

also:

The special question asked respondents to assign likelihoods to various price change scenarios over the coming year. 

Respondents’ mean expectation (weighted by industry share of GDP) for the change in the average price of their products and/or services was 1.5 percent.

Here is a chart depicting responses to the question of Year-Ahead Price Change Expectations:

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Recently Deloitte released their “CFO Signals” “High-Level Summary” report for the 2nd Quarter of 2013.   There are various notable items seen in the report; two items seem especially notable from a company profitability perspective.

First, as seen on page 5, regarding the importance of profitability to CFO compensation:

Growth is important, but profitability is still king when it comes to driving CFO compensation. More than 95% of CFOs report at least moderate influence and 75% report strong influence. But it is interesting to note that economic performance (through metrics like ROIC that incorporate both income statement and balance sheet measures) are the next strongest driver of CFO pay, with more than 70% of CFOs reporting moderate or strong influence. Also interesting is that measures more limited to the functional scope of finance (factors like liquidity, cost of capital, treasury returns, and tax efficiency) are considerably less influential – but there are important industry differences.

Also of note is an item seen on page 14 regarding (company) “Board Worries” of an external nature.  Under the “Industry” Category, “Intensifying Competition” (prices, tactics, etc.) is seen as having a high (relative to other worries) percent of CFOs naming the risk as a top-three concern.

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Corporate profitability – and its sustainability – is a critical topic at this time for businesses.

While there are many ways to measure aggregate levels of corporate profitability, those used most prominently portray that overall corporate profitability is at (very) high levels when viewed from a long-term perspective.

One way to measure the level of corporate profitability is shown in a chart comparing corporate profitability as a percentage of GDP.   This chart, in which corporate profitability is depicted on an after-tax basis, is also depicted below. (For the chart of Corporate Profits After Tax, please see the May 30 post titled “After-Tax Corporate Profits Chart 1st Quarter 2013.”)

Data Source: FRED, Federal Reserve Economic Data, Federal Reserve Bank of St. Louis; accessed May 30, 2013

This chart is through the first quarter and  the data was last updated on May 30.

A couple of statistics from the period shown on the chart, which dates back to the first quarter of 1947, include an average of 6.23% and a median of 5.87%.

As one might expect, other statistics concerning corporate profitability are also at or near record-high levels, such as the S&P500’s operating margins, operating profits, and EPS.

There have been various arguments offered as to the sustainability of current levels of corporate profitability; some arguments suggest that such levels are sustainable; others argue they are not.

There are various characteristics of this economic era that have been (very) favorable to corporate profitability; some of these factors include interest rates that, in general, are very low from a long-term historical perspective; subdued levels of wage growth; high-growth emerging markets that have expanded international sales – and in many cases margins; robust government deficits in many countries; and other factors.

I am of the belief (from an “all things considered standpoint”) that the current elevated levels of corporate profitability will not be sustainable; and the decline from these levels will have outsized ramifications in a variety of areas and for a number of parties.

In addition to the question as to whether corporate profitability is sustainable is the question as to what magnitude of a decline could be expected.  This topic is very complex and dependent upon many factors and assumptions.  However, it should be noted that a decline in after tax corporate profits as a percentage of GDP from it current level of 10.857% to the long-term average of 6.23% would represent a 43% decline.  Of course, due to a variety of factors, there is always the possibility of dropping below the average, perhaps substantially.

Such a decline in overall corporate profitability would likely impact each corporation differently, dependent upon a variety of its characteristics, including its industry, size, and numerous firm-specific business and financial characteristics.  From a corporate planning and risk management perspective, it behooves firms to (at least) contemplate, if not actively plan for a business environment in which a lower level of aggregate profitability exists.

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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 increase revenue and profitability.