No More Earnings on the Cheap?
The slow growth rate of the current economic expansion has been well documented. Only once in the past ten quarters has the domestic economy grown faster than the 3% long-term average. Yet for all the hand-wringing about if, or when, business activity will finally hit its stride, companies have reaped rewards of the measured acceleration in the form of higher profits.
The tepid pace has allowed companies to meet demand without taking on costly investments for additional capacity and machinery. As the chart shows, subdued capital expenditures (capex) have helped protect margins even though pricing power has been soft for many industries.
However, as the expansion approaches its eighth year, companies that have been able to get by with aging equipment and facilities may need to start dedicating more revenue to keep up with demand. Additionally, wages continue to creep higher and could further erode margins and profits.
We have long been hesitant to take a stake in businesses facing significant capex needs. Instead, we favor buying companies after the spending is done and valuations are often depressed due to the margin hit associated with the added costs of expansion. We believe this approach is sound regardless of the economic backdrop and is particularly prudent given the number of businesses that may need to upgrade facilities in the months and years ahead.
Past performance does not guarantee future results.
Investing involves risk, including the potential loss of principal. There is no guarantee that a particular investment strategy will be successful. Value investments are subject to the risk their intrinsic value may not be recognized by the broad market.
The statements and opinions expressed in this article are those of the presenter(s). Any discussion of investments and investment strategies represents the presenter’s views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. Any forecasts may not prove to be true.
Economic predictions are based on estimates and are subject to change.
Definitions: Capital Expenditures (CAPEX) are funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. Earnings Per Share: is the portion of a company’s profit allocated to each outstanding share of common stock. S&P 500 Index: is an index of 500 U.S. stocks chosen for market size, liquidity and industry group representation and is a widely used U.S. equity benchmark. All indices are unmanaged. It is not possible to invest directly in an index.
©2017 Heartland Advisors