Stocks A to Z / Stocks B / Berkshire Hathaway (BRK.A) ❤
No. of Recommendations: 5
No. of Recommendations: 9
expanding from 4% to 11% or so - 1995 to today
kinda of incredible
A bit unexpected, by me anyway.
One hopes that nobody confuses the cycle for a trend, which the added trend line and arrowhead on that chart are leading you towards. We know the trend shown has to have an end.
You can't say "what goes up must come down"--margins could stay this high for all I know. But you can observe that "what went up could go down"...the chart is proof that 4% is a possible number.
Jim
No. of Recommendations: 2
One hopes that nobody confuses the cycle for a trend
It's been nearly 30 years.
Is this one of those 43200 year cycles from Hindu texts?
No. of Recommendations: 4
the composition of the S&P is quite a bit different in the past 30 years. More profitable, less capital intensive and scaleable businesses.
No. of Recommendations: 6
the composition of the S&P is quite a bit different in the past 30 years. More profitable, less capital intensive and scaleable businesses.
Sure. As mentioned, it could stay high. (though the reasons it's higher are more to do with interest rates and labour share of income. If you're talking net income rather than cash flow, also tax rates)
But you can't extrapolate that trend. To make a buck of free cash flow requires much more than a buck of sales, and always will. The operating margin can't keep rising indefinitely.
Since you're talking about the whole economy, not just a couple of firms with great economics, it will probably always require (say) $5 or more of revenue even millennia from now. Businesses have expenses. Not a lot of people work for free, especially CEOs.
Jim
No. of Recommendations: 0
FCF growth and returns to shareholders helps explain some of the P/E expansion in the S&P doesn't it?
No. of Recommendations: 7
FCF growth and returns to shareholders helps explain some of the P/E expansion in the S&P doesn't it?
FCF margin is cyclical. If there is an upswing, perhaps some of that upswing is permanent, perhaps not. (usually not, but I'm open minded). The portion that is not permanent means it's just a short term squiggle, and stocks aren't worth any more than before the upswing. Farms aren't worth more in harvest season than they are in the winter...both situations come and go repeatedly. Only to the extent that the upswing is permanent are stocks worth any more.
Yes, it helps explain the P/E expansion (though not justify it): markets always pay a higher multiple of temporarily elevated earnings, as the average stock buyer has a short memory. It was ever thus.
Then margins fall again, and stock markets fall, and usually pay a low multiple of temporarily low earnings--just when they should be paying a higher multiple because the earnings are only temporarily low. Earnings were very low cyclically in 1983, and people wouldn't pay more than 10 times that temporarily low number. That's around the time that Mr Buffett spoke of his somewhat off colour "harem" feeling.
Jim
No. of Recommendations: 1
FCF margin is cyclical.
I searched and could not find historical data for FCF margins. Does anyone happen to have long term data for FCF? I am wondering if the margin is returning to its long term value when larger companies dominated the economy (first half of 20 century, or 1962 to 1965),rather than being at an unusually high point.
Aussi
No. of Recommendations: 10
I searched and could not find historical data for FCF margins. Does anyone happen to have long term data for FCF?No, but...
In general it will track profits extremely closely through the cycles, one main difference being tax rates, since FCF will be pre-tax.
This is a handy graph
https://fred.stlouisfed.org/graph/?g=cShIt's pretty cool that the number exceeded 8.5% only a single quarter in the half century from 1953 to 2004.
Yet has been
below that number only 3 quarters since then, all in the credit crunch. What used to be record breaking high is now record breaking low.
The old normal was maybe 6.5%, and the new normal seems to be above 10%, so each dollar of sales has been producing half again as much profit as it used to. Less going to labour and taxes and individual lenders (and foreign suppliers), the other main competitors for a share of the money.
Jim
No. of Recommendations: 3
As others have pointed out I believe the composition of American business is an important factor when analyzing historical margins and what may be normal or elevated.
If American business would get a super high concentration of McLanes for some quirky reason it wouldn’t mean that margins were at a cyclical low, it would just mean that American business was now concentrated to an industry where margins are inherently low (but still with decent returns on capital).
Actually I don’t think margins matter as much as returns on invested capital does.
A business with high margins can have low returns on capital and a business with low margins can have high returns on capital.
Competition is what regulates returns on capital. If some factory would earn 30% returns, a new one would quickly be constructed, selling the finished product cheaper to earn an acceptable 15% until industry returns would adjust.
The capital that enters this competitive equation is not on the balance sheet. The balance sheet is just an accounting invention and competition was regulating returns long before accounting was even invented. It is also not the actual capital invested in the business that matters but the capital required for the new guy to build the new factory. It doesn’t matter if someone gave you the factory or if it cost you a trillion dollars. If the new guy can build and earn a decent return the new factory will be built. Replacement cost is what matters when we are talking about what keeps returns on invested capital in check.
Now enter the modern firms, Google, Facebook, Microsoft etc. What is the replacement cost of their intangible assets? Another way to think about it: imagine a world where the balance sheet would accurately reflect replacement cost of the assets through some super calculation (I know but just a thought experiment). In this imaginary world I bet returns on capital wouldn’t look so high.
I have no clue where margins or returns on capital will go from here but I think the above are important considerations for anyone brave enough to put forward a forecast.
No. of Recommendations: 8
I believe the composition of American business is an important factor when analyzing historical margins and what may be normal or elevated. ...
I have no clue where margins or returns on capital will go from here but I think the above are important considerations for anyone brave enough to put forward a forecast. ..
I think those factors are a whole lot more important when you're considering any one company, or a few very large ones, or even an industry. When you're considering the entire US economy as a whole, top level macro limits come into play. Not every student can be above average.
The aggregate revenue of all companies in the economy grows (pretty much axiomatically) at the same rate as GDP, which is slow. That total gets divided up into only so many sectors: some goes to corporate profits, some goes to taxes, some goes to labour, some as interest to private lenders, and so on. In aggregate, none of those pieces can grow faster than GDP except at the expense of one of the other pieces.
It follows that the appearance of a few absurdly profitable large companies with very high net profit margins more or less requires that some other part of the economy be doing worse: the profitability of those firms does not remove the fact that over time the pie doesn't grow faster than GDP. Either a bunch of other companies are doing that much worse in terms of net margins, and/or the profits are arriving at the expense of labour or taxes or private lenders. Which might be temporary. In short, a few wildly successful firms with high net margins can not explain why economy-wide net profits can be growing faster than GDP. Because of the necessity that the allocations add to 100%, the aggregate high net margins have to be explained by shrinking shares going to the other sectors. Taxes, private interest, labour.
What is that analysis missing?
Cross border effects are large for other countries, but the changes are not very material by comparison for an economy as large as the US, so ignoring those can still give meaningful results. The government deficit is a very complicating factor...a huge debt-powered fiscal stimulus (whether government or private) is great for company profits for a while, but Ricardo would tell us that it's only borrowed from the future and will have a compensating drag at some time in the future when the debt is reduced. You have to be careful not to assume that (say) the S&P 500 typifies all companies in the US both public and private--the public companies could pull ahead (or fall behind) relative to private companies for a while. Though that's probably not a big factor, since public companies include almost all the big ones.
Jim
No. of Recommendations: 1
I think those factors are a whole lot more important when you're considering any one company, or a few very large ones, or even an industry. When you're considering the entire US economy as a whole, top level macro limits come into play. Not every student can be above average.
The S&P 500 is not a proxy for the entire economy...
tecmo
...
No. of Recommendations: 1
When you're considering the entire US economy as a whole, top level macro limits come into play.
...
The S&P 500 is not a proxy for the entire economy... Well, true, exactly as I mentioned in my post.
" You have to be careful not to assume that (say) the S&P 500 typifies all companies in the US both public and private--the public companies could pull ahead (or fall behind) relative to private companies for a while. Though that's probably not a big factor, since public companies include almost all the big ones."But in any case
(1) my suggested graph of corporate net margins WAS the entire corporate US, not the S&P 500 subset. (
https://fred.stlouisfed.org/graph/?g=cSh )
(2) the two results are not in any case all that wildly different. That's partly because such a broad set has aggregate economic characteristics not so different from the whole set, and partly because the S&P 500 covers a lot of the US economic corporate economic activity. For example, there are 81 non-bank companies in the S&P 500 with revenues over $40bn, and only 5 private companies of any type that big.
Jim
No. of Recommendations: 29
Dear Jim,
This post is an example of why I am in awe of you! How you are able, as you do so often, define an issue so concisely and on point?
I don't know. I may not always agree with you, and I know others don't always, either, but you always make me think and see the larger picture of subjects than i would ever do on my own. I appreciate that. And even when I don't know what the discussion is about, I like the way you say it. Usually with peace and respect.
Thanks,
Elizabeth
No. of Recommendations: 9
Usually with peace and respect.
Meh, it's all a facade. I'm obnoxious in person.
Jim
No. of Recommendations: 1
Jim,
You're a tech. guy, not a CFA. How did you learn so much about investing?
No. of Recommendations: 45
You're a tech. guy, not a CFA. How did you learn so much about investing?
I ran a company doing a lot of predictive modelling on big data sets (our biggest client was Excite, one of the pre-Google search engines), and co-founded an internet advertising firm. These were remunerative, so I had some money to invest. So I started trying those predictive modelling techniques on stock data, leading me to mechanical/quant investing. Then I started and ran a small hedge fund for about 6 years. (starting just before the credit crunch, alas)
Most of what I've learned that actually works has been from the back-and-forth conversations at these boards, and the reading and analysis I do in order to participate in them.
My best single rule of thumb: find a firm that is at least predictable enough that you can estimate their "pretty darned sure" average earnings per share 5-10 years out, and don't pay more than around 10-12 times that number. This works for profitless startups, steady-as-she-goes blue chips, and non-growing cash cows. And crypto ; )
Jim
No. of Recommendations: 1
“Meh, it's all a facade. I'm obnoxious in person.”
Yes, fake it til you make it!
Anyway, it’s a good fake.
