Tuesday, May 20, 2008

Profits & Profit Margins

THE BE YOUR OWN ECONOMIST ® BLOG

The stock market’s performance has generated some enthusiasm lately. Is the bad patch over?

Business earnings can provide a clue.

The following chart illustrates after-tax corporate profits throughout the economy. The huge increase since the 2001 recession inspired the stock-market gains that followed that slump. No other decade provided comparable performance.

But earnings in 2007’s last quarter were only $1,425 billion, marking 2007 as a year of little gain. (Update the following chart using that figure.) If profit growth has stalled, the stock market won’t continue to rise.

After-Tax Corporate Profits

(Click on chart to enlarge)

Recessions shaded

Manufacturer’s earnings confirm profits’ plateau. Manufacturer’s after-tax profits popped back up to $121 billion in 2007’s last quarter. If you update the next chart with that figure, it verifies the halt in a growth trend.

Manufacturers’ After-Tax Profits

(Click on chart to enlarge)

Recessions shaded

What happened to earnings? Why did they stall?

Total profit = Profit Margins X Sales Volume. Focusing on profit margins may provide a clue to the behavior of overall earnings.

The following chart shows the ratio of the price received per unit of output to the labor cost incurred in producing that unit of output. That’s a proxy for profit margins across the economy, and you can see that it, too, leveled off in 2007. If you update the chart with the fourth quarter’s 102.6, that confirms it.

Ratio: Implicit Price Deflator To Unit Labor Costs

(Click on chart to enlarge)

Recessions shaded

Finally, manufacturing confirms the trend. The next chart displays manufacturing margins in cents pre dollar of sales. They were back up to 7.7 cents at the end of 2007 (update the series in your mind’s eye), but that’s recovery not growth.

Manufacturing After-Tax Profits In Cents Per Dollar Of Sales

(Click on chart to enlarge)

Recessions shaded

What happened?

There’s been a squeeze. Business revenues have difficulty climbing while the residential-real-estate asset deflation continues. As wealth falls, demand weakens. At the same time, however, commodity inflation drives costs higher. So business is caught in a scissor’s crisis: Sluggish revenue and rapidly rising costs. Those circumstances squeeze profit margins and rein in profits.

If profits are constrained, how can the stock market reach new highs?

(The charts were taken from http://www.beyourowneconomist.com. [Click on Seminars and then Charts.] Go there for additional charts on the economy and a list of Economic Indicators.)

© 2008 Michael B. Lehmann




















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