No. of Recommendations: 8
Net profits have risen much more previously in the periods 1960 to 1965,1985 to 1997, and 2002 to 2007 than the recent rise. There is so much variation in net profits compared to revenue it appears to be more than variation in tax rates and interest rates.
Sure. Profits (net margins) go up and down, both with the business cycle (predictably) and on longer time frames (completely unpredictably as far as I can tell). Quite a few things go into that function.
But bear in mind that on that particular graph, the only difference between the red EBIT line and blue profit line is interest and taxes, by construction. The variation in the size of the gap between the lines is nothing but variation in interest and tax. You're right that there are a few other things going on affecting net profit margins at the margin (sorry), but clearly those two alone are big enough to make a huge difference and to be worth pondering deeply.
To me the interesting thing is not how fast profits have risen, but how far they have risen: the red line has got closer to the blue line than it has in about 75 years. Obviously the scales are different, but I presume that at some point net margins will top out and profits will grow no faster than sales, which is of course the normal (and necessary) situation over the long haul.
Recent US profitability is wonderful, and as a capitalist I celebrate it, but I would not want to be someone estimating optimistic company values (future earnings trajectories) based on the continuation of the post-millennium trend of net margin expansion. Given where we sit in the historical range at the moment (red and blue unusually close), I would think extrapolation based on sales (real GDP growth) estimates would be the sensible starting assumption for any firm, then add or subtract based on your solid evidence of how unusually good or bad the firm's prospects are. Remembering that there will of necessity be as much below-average growth as above-average growth in the economy; they can't all be above average. If aggregate earnings growth is going to slow down a lot, as seems mathematically inevitable, one has to wonder what multiples the market will assign to that slower average growth in profits.
As a PS, Mr Hussman follows the graph with a comment I have no way of checking. He has pretty good data sources, so I don't particularly doubt him, but the second part is somewhat surprising to me:
"The impact of tax reductions on corporate profit margins was nearly complete by the early 1980’s. Yes, statutory tax rates have declined further since then, but tax payments as a share of corporate revenues haven’t changed much in 40 years. That leaves declining interest costs from 1980 to the present as the clear driver of profit margin expansion in recent decades."
i.e., the recent narrowing gap between EBIT and E has been mostly due to I, not T.
Jim
