Has the High-Water Mark for Margins Arrived? It Sure Looks That Way

Corporate profit margins finished 1999 at just a shade under 6% of U.S. GDP. That year, Warren Buffett wrote a piece in Fortune stating that 6% was the upper limit of where profits could sustainably reside.

In 2021, margins exceeded 9% of GDP—surpassing even those levels preceding the Wall Street Crash of 1929. While we make no claims to timing markets at Kailash Concepts, we believe the high-water mark for margins may be here.

History is clear that margins are subject to various economic cycles and mean reversion. In downtimes, margins can amplify negative sentiment and exacerbate the "hangover" after such periods. In good times, they can foster irrational euphoria.

In his Fortune article, Buffett noted that between 1964 and 1981, the GDP grew 370% and the number of companies in the Fortune 500 sextupled. And yet, the price of the Dow Jones barely moved. The culprit? The lethal combination of shrinking margins (from 5.9% to 3.5%) and skyrocketing interest rates (from 4% to 14%) fueled investor pessimism. By Jan. 1, 1982, the combined market cap of all U.S. securities was just 36% of that year's GDP.

The outlook soon brightened. From 1982 to 1998, the S&P would compound at 18% a year and deliver a 1,656% return to investors. Soaring profit margins, falling interest rates, and modest GDP growth were the key economic drivers of the market's outstanding performance.

The chart below comes from Buffett's 1999 missive. It shows the after-tax profits of corporate America from 1929 to 1998. From 1951 to 1981 (after the 1929 crash, Depression, and wartime profits boom), margins generally stayed between 4% and 6.5%.

Source: Fortune Magazine; Data from 12/31/1929 - 12/31/1998

In the chart below from our piece Economic Cycles and Mean Reversion, we supplemented Buffett's numbers with data from 1999 to 2021.

As it turns out, Buffett was incorrect that margins of 6% or more are unsustainable for an extended period. But his rationale for this opinion was fascinating — and enlightening.