Are corporate profits anomalously high, and will it last? Or revert?

[daniellea]

I was reading this politifact post from December and I came across some striking graphs.

1. Profit per unit of real gross value added has blown up since 2000, from 5% to 16% of every dollar of value added (which is output value minus input costs, if I'm reading this right).
2. Corporate profits as a fraction of GDP are at near record levels, about 10%. The historical norm might be 6%, but it shot up around 2007, fell sharply, then recovered and went higher.
3. Buybacks and dividends grew by a factor of about 2.5 from 2009 to 2019, and then shot up some more in 2020, with a lot of variation across industries.

I'm thinking this was driven by a mix of low rates and corporate tax cuts.

Another manifestation of this might be divergence between trailing-12-month P/E (a relatively sane 21), vs CAPE (very high at 28), suggesting that current profits are high compared to CAPE's 10 year window.

This makes me think the that the wonderful 10 year, 10%+ per annum nominal returns I've seen in some funds I want to buy (SPHD, VYM, SPY) was not driven by growth, but by better extraction of profits from existing production. It seems earnings growth might be policy-driven, and thus unlikely to continue, and probably reversible.

Thoughts?

 

[tomi_]

@daniellea I don’t have the answer, but a few points:

• Profits per unit of real gross value added haven’t blown that much since 2000 if you look at the 1950-2022 curve. Since the 70s the trend is very clear. Which also happens to see the birth of modern computing, among others. Could a supercharged switch from an industrial to a service economy explain the trend?
• Taking 2009 as the starting point for comparing anything will skew the analysis. Years following it are abnormal because they’re the recovery time from “the Great Recession”. If you catch food poisoning, should you start your weight tracking right after the symptoms fade?

 

[daniellea]

@tomi_

Profit per unit of real gross value added haven’t blown that much since 2000 if you look at the 1950-2022 curve.

I think one needs to consider the idea that it is easier to grow from 5% profits to 10%, than from 10% to 20%, and impossible to grow from 20% to 40% (that's when they haul out the guillotines).

So the growth in profits we're seeing seems unsustainable, and the jump from 12% to 18% is post-2020, following a plateau at 12%, is suspect.

I will wave my hands and argue that 12% might be the new normal, but that a third of the 18% we're seeing is post-covid tomfoolery.

 

[wobblybobbly56]

@tomi_ Can you share the graph you’re referring to.

 

[tomi_]

@wobblybobbly56 It’s the link in OP’s 1st point.

 

[daniellea]

@tomi_

Could a supercharged switch from an industrial to a service economy explain the trend?

eg, 'death of unions'?

 

[alwayshavealwayswill]

@daniellea

eg, 'death of unions'?

Pretty much.

That's the effect of moving from an industrial economy that produces real property (e.g. "stuff") to a service economy that produces intellectual property (e.g. "processes", "ideas")....there's a reason why most railroad employees are members of unions and choose to collectively bargain with their bosses and why lower level employees at, say, McKinsey, KKR, Point72, or Cravath do not.........

Organized labor might slow the bleeding a bit, but as long as 70-80% of the worlds leading undergraduate institutions, law schools, med schools, etc are located in the USA, it's not going to reverse or slow down the pace of technological advancement.

TBH, I'm guessing you'd find this exact same trend in the 18th / 19th century when the USA transitioned from an agrarian / agricultural economy to an industrialized economy.

 

[kalu]

@daniellea One consideration: historically low interest rates made productivity improvements (new equipment purchases, expansion, etc.) very affordable. These low rates are no longer available. Consider the ramifications. Likely varies by market and company.

 

[km2018]

@kalu

productivity improvements (new equipment purchases, expansion, etc.) very affordable

I want to scream "but they spent it all on buybacks!" except I don't actually know how buybacks compared to equipment purchases. Is that information anywhere?

 

[elle22]

@km2018

I want to scream "but they spent it all on buybacks!"

Same. That means that with low rates no longer available, rolling over that debt pile will become quite a chore, eating into profits.

 

[deetbug]

@km2018 Here you go:

https://www.federalreserve.gov/econ...ent-an-international-perspective-20170411.htm

 

[sadie08]

@kalu Uh we arent that much higher than the 2018 rates.

 

[kalu]

@sadie08 Fed Fund rates up from 0.25% (Q1, 2022) to 4.75% today.

 

[yahj]

@kalu Some would say that's about 1900%

"NoT mUcH hIgHeR"

Definitely higher than I am right now

 

[yukonchris]

@yahj Can we get much higher?

 

[verah]

@yukonchris I can try

 

[katzenjammer]

@yukonchris I fantasized about this back in Chicago

 

[sadie08]

@kalu I specifically said 2018 rates. But thnx for the 2022 number.

 

[tuhermano]

@sadie08 It’s approaching double the 2018 number. That’s not nothing. Still hasn’t got back to where it was in 2006, but the point of the comment you are replying to is that there was an extended period of historically low rates — about 8 year’s worth, so indeed that encouraged a lot of spending that is less likely to happen now.

 

[boroughs09]

@sadie08 Under that theory it would be more about the cumulative effect over time than what the rates are doing at that moment. I doubt that is the main cause of high profits though.