Friday, September 11, 2009

Have Profit Margins Peaked?

Taylor Payne authored this blog. Taylor is President, Wealth Manager of Payne Wealth Partners. Please read more about Taylor here.

The London Financial Times reports that as a percentage of corporate output, second-quarter profits before depreciation, interest and taxes was 35%. Compare this to the long-term average for such margin of 29%.

Common sense tells us that as companies see their revenues fall, they had to aggressively cut costs and this has provided a boost to margins. However, such a lift to profit margins seems only temporary.

Banks have had huge margins given their low costs of funds and a steep yield curve that permits them to lend out at large spreads. These bank margins are not sustainable as the yield curve flattens.

Also, non-financial companies have received a profit boost from shrinking costs associated with reducing inventories (e.g. sell items from inventory that went in at a lower cost than present), but that is largely over.

With profit margins looking toppy and US stocks at about 18 times earnings it is difficult to see stocks making major advances from these levels.