04/05/11 Baltimore, Maryland – With the Fed’s self-fulfilling “wealth effect” taking hold…
…both the NASDAQ and Russell 2000 indexes reaching heights above April 2008…and talk of QE2 ending before the June 30 deadline, we begin today with a question: What is the most likely pin to prick this 24-month bull?
“Profit margins,” comes the plausible reply from Horizon Asset Management.
“Profit margins are near peaks,” writes Chris Mayer parsing the report into nuggets useful for our purposes. “Investors tend to like companies with fat profit margins, but high profit margins are like honey pots that attract competitors.
“They are rarely sustainable for long.
“What is more important for stock prices is not the profit margin itself, but the direction they move. Rising profit margins goose stock prices in wonderful ways, but declining profit margins are a tough anchor to overcome.”
The problem today is that most of the big blue chips report record profit margins. Let’s look at the tech sector. Here are the profit margins of top 10 tech stocks on the NASDAQ-100, listed in order of market cap.
The top 10 techs in the market are sporting an average profit margin of nearly 26%. That number is “without any historical precedent whatsoever,” Horizon notes.
“Profit margins are extremely high and unlikely to stay there,” says Chris, “which ought to lead to earnings disappointments down the road – hence Cisco’s one-day drop of 16% recently.”
The phenomenon extends well beyond techs. “There are quite a few companies,” in the top 50 stocks in the S&P 500, Horizon’s report says, “with very high absolute profit margins.”
The nontech list is notable: Coca-Cola, Schlumberger, McDonald’s, Occidental Petroleum and Freeport-McMoRan Copper & Gold “all have the common feature of after-tax net profit margins well in excess of 20%…
“In general, a 20% profit margin for any company is a historical rarity.”
“In some ways,” Chris observes, “the surge in profit margins is what you would expect to see in the early phases of a recovery. Companies cut costs going in a downturn. Then, as sales rise, there is a big boost to the bottom line, as costs have yet to catch up.
“Today, though, I doubt many of these firms have much more to cut.
“Instead, the focus is now growing sales and taking business from competitors or defending an existing business. The focus, too, is how to deal with rising raw material costs. All of these put enormous pressure on margins.
“We should expect to see them fall.”
Addison Wiggin
for The Daily Reckoning
Addison Wiggin
Addison Wiggin is the executive publisher of Agora Financial, LLC, a fiercely independent economic forecasting and financial research firm. He’s the creator and editorial director of Agora Financial’s daily 5 Min. Forecast and editorial director of The Daily Reckoning. Wiggin is the founder of Agora Entertainment, executive producer and co-writer of I.O.U.S.A., which was nominated for the Grand Jury Prize at the 2008 Sundance Film Festival, the 2009 Critics Choice Award for Best Documentary Feature, and was also shortlisted for a 2009 Academy Award. He is the author of the companion book of the film I.O.U.S.A.and his second edition of The Demise of the Dollar… and Why it’s Even Better for Your Investments was just fully revised and updated. Wiggin is a three-time New York Times best-selling author whose work has been recognized by The New York Times Magazine, The Economist, Worth, The New York Times, The Washington Post as well as major network news programs. He also co-authored international bestsellers Financial Reckoning Day and Empire of Debt with Bill Bonner.
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I think the better question on tech stocks is how long Americans will continue to buy the tripe produced by tech companies. My wife is a school teacher and often comes home with stories of how kids come to school hungry, yet have the latest in technology. Whether it’s the latest palm phone or Ipad2, (worthy of note but off of discussion is the same goes for their clothes) these children have satellite TV, Internet, computers, Plasma TV’s at home, yet lack the very basis to survive and do well. I think it is safe to say that as long as Americans continue to have skewed priorities, the tech market will do just fine.
according to the last ISM report, many buyers’ jaws were agape at the # and amounts of input price increases, which, indeed gets a mention here. inflation.
lacking is the degree to which these margins have been goosed by these companies’ ability to control product pricing, the “other half” of margins.
well you’re prob right that they’ll go down from here. but serving leftovers of a 1/2-baked Meyers dish the day after ditto a 1/2-baked Bonner dish? yuk!