U.S. companies remain 'extremely' profitable

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Enough has been said about “greedy inflation” in the United States, and it is no longer very controversial to discuss systemically important prices.

The profitability of U.S. companies is still quite high and is likely to rise further this year. Goldman Sachs economists expect overall profit margins for non-financial companies to rise slightly this year, to 16.3%.

However, they do not believe this will have much of an impact on inflation. Even if profit margins are well above worrying levels in 2016, no one questions the “validity of capitalism.”

First, a quick look at how their aggregate profitability figures compare to historical data and how they are measured: GS compares the profits of non-financial companies to their GDP output. By this measure, corporate profitability reached its highest level since the 1960s in 2022 (excluding Covid-19-related government transfers) and remains above various peaks reached in decades.

But even with profit margins high, inflation should slow as it is offset by lower input (i.e. energy and materials) costs and lower labor costs, Goss said.

This is not to say that Americans will immediately experience lower prices as a result of lower input costs for companies:

Intermediate input costs fell by about 3% last year, and we expect cost reductions to improve margins in the short term. While we previously found that changes in input costs are mostly passed through to final prices in the long run, we find that firms absorb input cost increases faster than input cost decreases. Assuming intermediate inputs remain at current levels, we estimate that lower input costs will increase non-financial corporate profit margins by 0.2 percentage points in 2024.

This is not surprising, especially after we got a very clear picture of the dynamics from interest rates and banks. (When they go down, everyone goes down. When they go up, bank customers don't see it for a while.)

They also talked about artificial intelligence and technology companies and profit margins. But as Alphaville readers know, the AI ​​hype seems to be mostly about labor costs. These are also expected to drop this year:

Another way to quantify the impact of wage growth on profit margins is to estimate the extent to which changes in wage growth are passed on to prices or absorbed into profit margins. Using a set of industry and state-level panel regressions, we estimate that a 1 percentage point increase in wage growth increases price inflation by about 0.3 percentage points (Exhibit 9). Since employee compensation accounts for about 60% of GDP, this means that for every 1 percentage point drop in wage growth, profit margins increase by about 0.3 percentage points – net of a 0.6 percentage point drop in costs and a 0.3 percentage point drop in prices.

Finally – and perhaps most interestingly – economists looked at how higher interest rates are reflected in companies' income statements and profit margins.

. . .we estimate The company covers about 30% of higher interest expenses through reduced capital expenditures and labor costs, with the remainder absorbed by profit margins. This means higher interest payments will have a drag on profit margins of about 0.1 percentage point this year.

This seems like a pretty confident statement. How do economists come up with these numbers? Here is an article published last August:

Using firm-level data on public companies since 1965, we estimate the impact of higher interest payments from refinancing on capital spending and employment. We find that for every dollar of additional interest expense, companies reduce capital expenditures by 10 cents and labor costs by 20 cents, with roughly half coming from lower employment and half from lower wages.

Um. So this data window opens in 1965, when nearly 31 percent of the private sector workforce was unionized.But what I want to talk about today is 7% —The modern worker finds himself entirely on the wrong side of the average calculation.

For unprofitable companies, the calculation is quite different and more severe. According to the August 2023 note, there are many more such questions:

In previous research, we found Unprofitable companies disproportionately cut employment and capital spending when faced with profit pressures. The left panel of Exhibit 9 shows that almost 50% of listed companies will not be profitable in 2022.Unlike a typical recession, the right panel of Exhibit 9 shows the exit rate of unprofitable companies reject Reflecting a decline in insolvency rates across the economy since the start of the pandemic (perhaps in part due to the withdrawal of generous fiscal support).

This again raises a different debate, about whether concerns about zombie companies should be less about returns and more about jobs and investment.

Fortunately, the company's refinancing needs did not That The pressure is high because many countries issued debt in 2020 and 2021 when interest rates were low.

In its interest cost study last year, Goldman Sachs found that if companies continued to refinance debt at prevailing rates, when Treasury yields were very close to current levels, the median corporate bond coupon would be just half a percentage point higher in 2025. This applies to both the investment-grade bond market and the high-yield bond market.

in other words:

Overall, our estimates suggest that economy-wide non-financial profit margins are likely to edge up by about 0.1 percentage point this year to around 16.3%, above pre-pandemic levels and the peak of the previous cycle. Still, high profit margins should be consistent with continued deflation, as lower input and labor costs and the shrinking scarcity effect are likely to continue to hold inflation down in 2024.

So, nothing to worry about here! ? Newly unemployed Americans can apparently enjoy gas prices of $3 a gallon while the corporate profit machine continues to grind. ˙\_(ツ)_/˙