Investors Watch Record Profit Margins for U.S. Companies as Costs Continue to Rise
By Caroline Valetkevitch
NEW YORK (Reuters) – U.S. businesses have maintained strong profit margins during the pandemic because they cut costs and passed high prices on to customers. The question is: how long can this last?
With inflation still high, the ability of companies to keep margins at record highs is being closely watched by some investors and strategists as third-quarter earnings reports from S&P 500 companies are expected to arrive next month.
Much higher than expected earnings have been key support for stocks this year, even as the coronavirus pandemic has continued. The S&P 500 Index is up about 17% for the year so far.
Given the way companies manage costs, profit margins are expected to increase in the near term, said Jonathan Golub, chief U.S. equities strategist and head of quantitative research at Credit Suisse Securities in New York.
“Companies are doing a great job of managing costs in a tough environment,” he said, and that has led to “really strong profit margins”.
“It’s not going to last forever, but will it last a little longer? The answer is yes.”
For the second quarter, the operating profit margin of S&P 500 companies was estimated at 13.54%, exceeding 13.02% in the first quarter, which was also a record, according to data from the S&P Dow Jones indices.
Analysts expect S&P 500 profits to rise 29.5% in the third quarter after a huge 96% jump in profits in the second quarter, when comparisons a year ago were much easier, according to the reporters. IBES data from Refinitiv from Friday.
In a recent trend reversal, analysts reduced third-quarter earnings estimates slightly, the data showed.
Companies have faced rising costs due to the coronavirus pandemic-related shortages of raw materials and volunteer workers.
BofA Securities strategists wrote in a recent note that there are signs that inflation has shifted from a tailwind to a headwind. “When married to a slowdown in macroeconomic data, companies may find it more difficult to cope with cost inflation,” they wrote.
A key factor for margins is the spread between costs and the ability of companies to pass those costs on, Morgan Stanley strategists wrote this week.
The gap between the consumer price index and the producer price index “has become deeply negative as high commodity prices, rising logistics and distribution costs and higher wages exceed trader’s final prices – a scenario that increases the risk to corporate earnings over the next 12 months, ”they said.
Recent data from the PPI suggests that high inflation is likely to persist for some time as the relentless COVID-19 pandemic continues to put pressure on supply chains. This has led some economists to lower their estimates of economic growth in the third quarter.
Producer prices in the United States rose sharply in August, leading to the largest annual increase in almost 11 years.
It all depends on what will change in the coming months.
“In the very short term here, it’s hard to read too much into these numbers,” said Sameer Samana, senior global markets strategist at the Wells Fargo Investment Institute in St. Louis.
If economic growth slows and wage growth slows, there is less of a problem for businesses, he said. But, “it’s hard to see how things are improving from an operating margin perspective.”
(Reporting by Caroline Valetkevitch; Editing by Alden Bentley and Mark Porter)