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.
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.