Opinion

The Edgy Optimist

Why high corporate profits aren’t so bad

By Zachary Karabell
May 1, 2013

Over the past month, America’s largest companies reported their earnings for the first quarter of the year. These quarterly reports provide as much insight into our economy as any of our leading indicators. And these results, if read correctly, highlight once again the bifurcated world we live in. Our gross domestic product is growing about 2.5 percent a year for now, but that masks a vast divergence, not between the 1 percent and the 99 but between what works and what does not. What this earnings season demonstrates is that capital and companies are thriving, along with tens of millions of people connected to those worlds, while labor and wages are not. But that is not how it is being interpreted.

The consensus among investors and the financial media is that the quarter was something of a bust, as company after company reported only modest – and in many cases, non-existent – revenue growth. “Revenue still missing as companies beat earnings,” blared a USA Today headline, and that encapsulates what most have said.

The uber-bearish economist Gary Schilling, cited by the widely-read uber-gloomy blog Zero Hedge, put it bluntly: “Pricing power has been non-existent [and] sales volume increases have been very limited so the only route to profit has been cutting costs. That has pushed profit margins to all-time highs.” Enjoy it now, says Schilling, because profit without revenue growth is “unsustainable.” The only reason markets are doing well and corporations aren’t panicking, the thinking goes, is because central banks are flooding the world with money.

At the same time, large companies have proven adept at generating substantial earnings. That is true now, and it has been true for years. Since 2009, for instance, the mega-companies of the Standard and Poor’s  500-stock index have doubled their profits. Companies overall haven’t done quite as well because small companies don’t have the same advantages, such as keeping income offshore, assorted tax breaks and pure economies of scale. Even so, according to the Bureau of Economic Analysis, U.S. corporations overall have seen their profits grow more than 50 percent during these years.

But now, while larger companies are still showing earnings growth, revenues have been almost at a standstill. This trend is widely seen as proof that trouble is brewing. Companies, especially publicly traded ones, face relentless pressure to generate earning growth at all costs. With slower revenue growth, the only way they can do that is to cut costs and do whatever they can to become more efficient, from greater use of technology (and therefore fewer workers) to cutting wages and benefits, either by finding cheaper labor abroad or by cutting benefits and wages domestically. In a world of slow revenue growth, that becomes harder. Says Jeffery Kleintop, chief market strategist of the financial firm LPL, companies are going to have a hard time eliminating enough expenses to hit earnings targets. “When there’s no more fat to cut,” he says, “you start to cut muscle, and then you’re cutting bone.”

The problem with these views is they rest on the belief that companies are revenue-challenged. That may be true for some companies over the past few quarters. But it simply isn’t true overall.

Since 2009, while the global economy has grown less than 4 percent per year, on average, companies have generated revenue growth at almost twice that rate. As for companies engaged in the more dynamic areas of our economic lives ‑ technology companies, innovative retail companies, industrial companies ‑ those have grown at an even faster clip. What’s more, the average rate of growth is weighed down by financial companies‑ though overall that is a good thing, given how bloated and outsize the financial industry had become before 2009.

More important, while some companies are finding it hard to generate growth, over the past four years the sectors we would want to shrink are shrinking while the sectors that stand to materially improve our lives have been booming. Financial services, some healthcare companies, coal and oil producers – those are the industries that have been challenged. The shrinkage of these sectors is a good thing; you don’t want healthcare costs eating up larger portions of national income (which remains a problem); you don’t want energy costs crowding out other consumer spending; and you don’t want a bloated financial services sector. Meanwhile, Google, Amazon, eBay, Apple, Honeywell, United Technologies, Netflix, Target and on and on ‑ those have thrived. And they’re not thriving at the expense of society, whatever the rhetoric about inequality would suggest.

Yes, there is massive inequality, and average wages have stagnated in the United States and decreased in much of the developed world. But that is the average. Within that, wages for the college-educated, for the skilled and for residents of dynamic urban areas have been growing rapidly and robustly. Google would not be generating almost $60 billion in revenue this year unless millions of businesses large and small were using banner ads and search to expand their businesses, and they can only spend that money because their businesses are, in fact, expanding. EBay is growing at double-digit rates because PayPal is booming, and it wouldn’t be booming without those millions of consumers using it for payments.

How we view corporate earnings is being distorted through various negative lenses. One lens says macroeconomic growth defined by GDP is slow and getting slower and companies are about to slow down far more than we think. Another lens says the relative success of companies is coming at the expense of substantial swaths of society. Neither lens allows for the fact that companies are doing well because vast swaths of the globe are booming, including substantial numbers of people not just in China and the emerging world but also in the United States. That boom isn’t just a function of creative accounting and cost cutting. It’s because so many are doing quite well in the world today even as many people struggle mightily.

The economies of today are simultaneously serving the needs of more people than ever while failing to provide sufficiently for vast numbers of people. That explains why so many companies are succeeding so spectacularly, and why that trend is likely to continue for quite some time. They thrive because many are thriving, and because they bear few of the burdens of states that must provide for those who are not thriving. Healing that split is one of the challenges of our day. Thankfully, the thriving companies are the ones are most likely to be part of those solutions.

PHOTO: A member of the Occupy Wall Street movement, Emma Wolfson, waves a flag in protest of corporate profits in Zuccotti Park near the financial district of New York October 12, 2011. REUTERS/Lucas Jackson 

Comments
8 comments so far | RSS Comments RSS

This observer has correctly perceived “…a vast divergence, not between the 1 percent and the 99 but between what works and what does not.” Hallelujah! At last, eyes are opening!

“The economies of today are simultaneously serving the needs of more people than ever…”. If they are unable to”…provide sufficiently for vast numbers of people…” has that not ever been so? Let us not make the perfect the enemy of the good. Is not our glass well beyond “half full”?

“…many companies…thrive because many are thriving, and because they bear few of the burdens of states that must provide for those who are not thriving. Yes! Yes!

It is the obligation of all of good will towards their fellow man to improve the lot of those on the bottom through no fault of their own. It is quite another thing to place responsibility on any society to provide lavish benefits on the slothful and “unworthy poor” who see no shame in accepting the bounty of others’ investment, inventiveness or extra effort.

It is this distinction that allows America to remain the economic “lead engine” of the world’s economy. I do fear a future when Americans have “dumbed down” to a point where they will deliberately kill the “goose that lays the golden egg” even as they know not what they do.

Posted by OneOfTheSheep | Report as abusive
 

Yeah, it’s not bad if they would pay a tax rate that is also fair, now and for the last 50 years they haven’t paid a penny.

Posted by ditdah | Report as abusive
 

we have replaced a huge number of highly paid consumers with technology or outsourcing.

the paychecks are gone. chinese workers don’t make as much money as the workers they replaced..

there aren’t enough rich people to make up the difference…fewer customers means less volume, consumed……(there is only so much beer one individual can drink…….there are only so many BMW’s, that a person needs).

that could be reflected as an inability to generate more year over year revenue growth, yes?

Posted by Robertla | Report as abusive
 

Korporate profits based on what? cutting costs…..outsourcing employment…investing in projects abroad? It seems that these Multi-National Korporations with Amerikan names do not like to invest in the land that spawned them.

Posted by rikfre | Report as abusive
 

@ditdah,

Some forms of corporations are taxed not once, but TWICE! That said, it is not business (all types) that pays business taxes but those who purchase their goods and services. Those taxes are pare of the “sale price”. It is, and has long been, legitimate to deduct the “cost of doing business” from “gross profit”.

“Don’t tax you, don’t tax me, tax that fellow over under that tree”.

Posted by OneOfTheSheep | Report as abusive
 

Unfortunately many people like Oneofthesheep also believe that survival equals “lavish benefits” and that only by ending aid will the unemployed re-join the workforce. As usual, this comes from a fearful and myopic viewpoint regurgitated by the Birchers and is far removed from reality.

Ditdah on the other hand has the right idea but incorrectly believes companies (I believe he’s referring to) have paid zero taxes in 50 years. Some large corps have paid some taxes 2 out of 5 years for example, but lumping that predatory behavior into ‘all companies’ and ‘not a penny’ and 50 years is just as exaggerated as assuming welfare cheats are stealing your taxes worse than corporate welfare, deregulation (read no regulation), no bid defense contracts, etc. etc.

Today’s economy reflects the diminishing returns of 30 years’ worth of corporate practices. Even more robots will only quicken the realization that we have to overhaul education and re-skilling in this country. As China matures other countries will replace it’s low price labor. Hopefully in Central America, Mexico, etc. so a middle class solidifies there.

What we could really use is another way of valuing corporations instead of via the stock market and it’s what have you done for me today modus. If only private companies can invest for the long term w/o being crucified we will remain in this strange atmosphere of LBO’s and valuation based on stock price and dividends.

Posted by Mac29 | Report as abusive
 

@rikfre,

You don’t seem to understand investors or investing.

In many ways it is like farming. The successful farmer does not walk out of his house just any day of the year and “invest” his seed into the ground. He does not plant “on faith” in a persistent drought and long survive.

He considers the seasons and his local climate for the “best growing season. He takes likely freezes into account. He wants the fields to have sufficient moisture for seed to sprout and grow, yet be dry enough to prepare for planting.

So if the “investing climate” is better for profit outside the U.S. than inside, that is where the successful investor invests. Whenever it is “equally good” or better here in the U.S. he invests here, for many reasons.

It is simple fact that the land of his birth is not always the most fertile at a given time. Nothing personal. Survivors know there are good times and bad times and plan to survive both in the long term.

Was it your intent to “come across” in your spelling and tone as a dissatisfied youthful anarchist? Just askin’

Posted by OneOfTheSheep | Report as abusive
 

Zachary, you are confusing the diminishment of human labor through automation as an indication of economic vitality. While that may be a benefit to investors through improved earnings despite reduced revenue growth, it is very clearly not beneficial to an economic system that requires cyclical financial throughput for a continuing society. A larger, richer share of the pie for a smaller group of people is not a sustainable economic plan.

Posted by StevenMitchell1 | Report as abusive
 

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