Over the past 30 years, S&P 500 profit margins more than doubled, from 5% to 12%.
In layman’s terms, corporate America is more than twice as profitable today as it was in 1990.
The expansion of corporate profitability during the last three decades makes for a stark juxtaposition with the two preceding decades, when margins actually compressed.
It’s no coincidence that we can date the onset of America’s profit renaissance to the rise of shareholder capitalism and the dawn of the hyper-globalization era. Since the late 1980s, stakeholders other than stock owners have seen their interests subjugated to the bottom line again and again. There’s no clearer manifestation of that than the inexorable decline of labor as an economic actor with clout.
It might be tempting to attribute some of this dynamic to the rise of the tech sector, but that wouldn’t be right. As Goldman analysts including Ben Snider pointed out in a note dated May 16, “the same trend is evident looking just at the profit margin of the median index constituent, and also when controlling for sector composition.”
Note from the figure on the right above that it doesn’t matter which sector you choose — net margins are either at or near the upper-end of their respective distributions since 1990.
Snider broke down equity returns over the period and found that 40% of the S&P’s gain over three decades is attributable to margin expansion. Crucially, he wrote, corporate America’s capacity to grow earnings consistent with the longer-term trend depended entirely on companies’ ability to keep expanding margins in the face of slower revenue and GDP growth.
“Going forward, unless margin expansion continues, trend revenue growth reaccelerates or equity valuations soar to new record highs, the trajectory of equity market returns will fall below the trend,” Snider said.
This is a hot topic in 2023, as politicians and policymakers debate the role of so-called “Greedflation” and alleged profiteering in keeping consumer prices elevated despite central banks’ efforts to restore price stability. While you can make the case that the dynamics are more acute now — that companies have exploited unprecedented pricing power over the past two years — the reality is that corporate profitability has been expanding for decades.
I’ve said it over and over again during the “Greedflation” debate: This is in part a function of choices we made in the US. We instituted and facilitated a brand of capitalism that worshipped profits, and here we are. It’s a bit disingenuous to blame corporations now, after 30 years, and to pretend as though this is something new just because inflation is high.
And make no mistake: This is predominately a US phenomenon. As Goldman noted, “the strength of S&P 500 profit margins has been a key difference when compared with other global equity markets.” Over the last 10 years, US profit margins were 300bps higher than the rest of the world, for example.
COGS are the key. They’ve declined from nearly three quarters of S&P 500 revenues to less than two-thirds, while margins were also boosted by falling rates and lower taxes.
The tailwind from COGS actually began to diminish a decade ago, Snider noted. It’s probably fair to suggest that by 2010, quite a bit of the cost savings from globalization, offshoring and JIT were realized, and in any case, the world changed in 2020. “Recent supply shocks have generated a new corporate focus on operational resilience at the potential expense of cost optimization,” Goldman wrote.
Ultimately, Snider warned that all three major drivers (i.e., COGS, rates and taxes) are likely to “reverse in the years ahead.” The shift from just-in-time to just-in-case and higher labor costs are obvious examples, but “higher for longer” rates (ironically a function of elevated inflation driven in part by companies’ efforts to boost margins) and the prospect of higher taxes amid societal blowback from decades of worsening inequality, all threaten to crimp profits.
“The major margin tailwinds of the last 30 years are unlikely to provide much boost” going forward, Snider cautioned investors, adding that “without continued profit margin expansion, S&P 500 returns risk falling below the long-term trend.”
On the bright side, Goldman said, “strides in A.I. technology represent potential future tailwinds” to profitability.
the last line in this article is all that matters. Anyone who has worked in any environment knows there are still plenty of inefficiencies in any organization. be it in the design, production, supply chain, marketing, or any other department. One of the reasons that profits keep increasing is that businesses have better metrics on their processes and are learning how to use them better and better over time. AI is only going to accelerate this. The big will get bigger and the rich will get richer. They have the best talent and resources to exploit the new technologies.
I agree Michael. It’s so easy to look at these statistics in a narrow context and then fail to identify underlying reasons for margin expansion and ignore other significant trends like AI, that will have a dramatic impact on margins.
You mentioned falling rates- I think this is very important to the story- it has resulted in more leveraged companies and larger public debt….To me this signals behavioral change as rates rise…
Doesn’t the US tax environment also play a part?
Reagan for 2 terms and then Bush, Clinton profited from both globalization and the internet, then Bush Jr’s 2 terms clearly juiced things (2 wars and deregulation inevitably) leading to the GFC. Obama did not rock the corporate boat and Trump infamously goosed corporates again.
I don’t actually believe the voters in every case were saying “Yes make corporations richer and bigger”.
Replying to myself: it’s only very recently that the international “irish sandwich” and global tax rate showed up – for decades multi-nationals have structured themselves out of taxes while simultaneously benefiting from US workers, markets, courts, banks, hospitals, schools, etc
Great points there.
The voters were saying “those poor deserve to be poor” and/or “I don’t like black and brown people overmuch” and the GOP managed to say “yes ; and let’s make corporations richer and bigger” while the Dems were saying “no, no, no, you’re wrong, those poor deserve help and Black and brown people should matter too”.
You can see who won in the graphs provided by our host…
There was some pushback from populist voices on the left and on the right as well. But the whole rightwing propaganda machine (Americans for Prosperity, ALEC and such) were able to get any criticism dismissed as socialist trojan horses.
In retrospect, one such voice, Ross Perot, looks to have been rather prescient, don’t you think?
“We have got to stop sending jobs overseas. It’s pretty simple: If you’re paying $12, $13, $14 an hour for factory workers and you can move your factory South of the border, pay a dollar an hour for labor, … have no health care—that’s the most expensive single element in making a car— have no environmental controls, no pollution controls and no retirement, and you don’t care about anything but making money, there will be a giant sucking sound going south.
... when [Mexico's] jobs come up from a dollar an hour to six dollars an hour, and ours go down to six dollars an hour, and then it's leveled again. But in the meantime, you've wrecked the country with these kinds of deals."
Were the invasions of Iraq and Afghanistan profitable to corporate America? I am confident Desert Storm was. We will not being doing wars like that anymore.
Since Perot was mentioned, 30- years later Perot’s instincts and initiatives may end up putting him in saint territory, for a couple hundred thousand forgotten and abandoned sarin poisoned Desert Storm veterans.
Over the last 30 years our sourcing of goods from China, other SE Asia, etc. has undoubtedly contributed to margin expansion. No matter the politics, companies that have benefited most from these cheaper supply chains will not give up those fat margins easily. I’m going out to lunch today in a beautifully made, $45 dress shirt from Vietnam. Others like it can go for $220. Not for me.