Huge Disparity in Corporate Profits Hints at Something Amiss
14 December 2019 - 1:29PM
Dow Jones News
By James Mackintosh
Are U.S. companies making more money than ever before, or are
they mired in one of their longest profit slumps since World War
II? Widely used measures have diverged in recent years, leaving
many investors worrying that something is amiss.
Look at pretax domestic profits as measured by the Bureau of
Economic Analysis, and it is easy to be bearish. Profits are down
13% in five years, the biggest drop outside a recession since World
War II. President Trump's tax cut has cushioned the blow to
earnings, with after-tax corporate profits falling only a little.
Profit margins also are down sharply, with the pretax margin for
domestic business lower than the postwar average and below where it
stood from World War II until 1970.
Falling domestic profits suggest companies are in deep trouble,
avoiding an even deeper slump only thanks to tax cuts.
Earnings by S&P 500 companies tell the opposite story.
Reported earnings per share were at a record in the 12 months to
June, up 31% in five years and forecast to keep rising. The
after-tax profit margin is slightly down from a record last year,
but still higher than any time before that.
Some investors are worrying that the gap between the weak
profits and the record per-share earnings of the S&P 500 is a
repeat of the warning signs of the late 1990s, when listed
companies exaggerated their figures. There is probably some of
this. Some such excesses usually build up during long periods of
economic growth.
Another factor: High S&P profits have led many to conclude
that U.S. businesses are raking in money in a way more consistent
with oligopoly than a free market.
A deep dive into the numbers suggests most or all of the gap is
explained by other elements. Much of the gap between S&P
earnings and the national figures appears to be due to tax dodging
by multinationals, the troubles of smaller businesses and that the
big-company index includes more successful companies than the wider
economy.
Stripping out tax narrows the gap. That is because big companies
benefited more from the tax cuts than small businesses. Goldman
Sachs analysts point out that the tax rate on the S&P dropped
by 8 percentage points, from 26% to 18%. The economywide corporate
tax take dropped by a smaller 5 points from 16% of profits to 11%,
partly because the economywide data includes nonprofits and
corporate structures where the tax is paid by the shareholders, not
the company.
The rising use of tax havens to shift offshore patents and other
intellectual property rights -- and their fat profits -- probably
makes up much of the remainder. Figures here are sketchy.
Researchers at the Minneapolis Federal Reserve last year estimated
that roughly $280 billion of profits had been shifted by U.S.
companies offshore in 2012. That would equate to tax revenues of as
much as $100 billion. Add that back in, and after-tax profits are
at a record, as with the S&P.
S&P profit margins before tax fit this pattern, too. They
peaked in 2014, and have come down a little since then, though by
less than the fall in margins. This suggests in part that a pickup
in wages has started to eat into margins in the past few years,
rather than being about the internet giants creating new
monopolies.
However, Jonathan Tepper, author of "The Myth of Capitalism" and
founder of research house Variant Perception, says the drop in
pretax margins is a result of being late in the economic cycle, and
is compatible with reduced competition leading to a multidecade
trend higher in profitability.
Internet giants such as Alphabet and Facebook have skewed the
numbers, though, along with other successful technology stocks.
S&P 500 companies are far more profitable than small and
midsize listed companies, in part because of the much heavier
weighting of the tech sector in the blue-chip index.
Accounting shenanigans might play a part. As independent
economist and author Andrew Smithers points out, CEOs were given
incentives by bonus structures to overstate public-company
write-downs in 2008 and 2009. That likely boosted stated profits,
and bonuses, in later years.
The next bust will probably reveal accounting misdeeds from the
long stock market boom, if history is any guide. The profits
disparity can mostly be explained with tax, size and sector
differences. But we will only know for sure when the market next
crashes.
Write to James Mackintosh at James.Mackintosh@wsj.com
(END) Dow Jones Newswires
December 14, 2019 08:14 ET (13:14 GMT)
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