Investors routinely attribute today’s near-record margins to operating efficiencies like factory automation and the outsourcing of labor to lower-wage foreign locales. This is certainly an attractive story, but the reality is that competition demands these actions, and many more, to merely maintain margins.
We don’t understand why economists who seem to be perfectly good capitalists in every other way think these innovations should result in a permanent jump in profitability.
For the third quarter, the National Income and Product Account (NIPA)—a broad measure of profitability that includes both public and private companies—came in at 10.1% of GDP, ticking up from a revised 10.0% in the second quarter. The all-time record of 10.3% was established in the fourth quarter of 2011.
The table is clear: the margin expansion story of the last 20 years is a financial one, not an operating one. Net profit margins have increased to 10.1% in the latest quarter from a technology-boom peak of 7.3% in the third quarter of 1997.
But operating (or “EBIT”) margins have barely budged since that 1990’s peak—up only 20 basis points. The key developments have been the continuing shrinkage of interest expense and (secondarily) the corporate income tax burden; relative declines in these two items account for 2.6% of the 2.8% jump in net profit margins since 1997. Boring, but true.
What’s clear is that the predominant effect—the drop in interest expense—has almost certainly fully run its course. What will move margins next? Some might say 3-D printing, or even drone deliveries from Amazon. Our best guess? Gravity.
© Leuthold Weeden