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The Truth About Corporate Profit Margins

I usually avoid “technical” market commentary.

However, this topic has been frequently covered in the media lately, so I want to provide some historical perspective to combat the fears being stoked.

The main fear is that corporate profit margins will decline from their historically high levels.

And some think this would be catastrophic.

While this may not initially provide great comfort, let me save you the suspense:

Corporate profit margins will eventually decline.

And when they do, stock prices may follow, at least temporarily.

I share that uncomfortable truth with you for two reasons:

1) If we’re prepared, we’ll be less likely to panic. If we don’t panic, we’ll hopefully stick with our thoughtfully crafted financial plan.

2) Fluctuating profit margins are a natural and recurring part of the business cycle. Even if we look back to the start of 2000, we can see that profit margins have fluctuated dramatically.

Yet, despite this fluctuation, the S&P 500 has risen from 1,455 on the first day of trading in 2000 to over 6,000 today.

Incredibly, this period includes...

...three recessions, two of the worst declines in our market's history, a major terrorist attack, multiple wars, a pandemic, countless debt ceiling debates, and much political strife.

Despite all the drama during this period, the historical performance should reinforce that we didn’t need to jump in and out of the market to achieve a satisfactory return; we just needed to stay the course.

That said, you might be wondering how or why the market has performed so well over this period (and over the last 100 years).

While this is a complex issue involving hundreds of variables, I think we can connect much of the performance to the cumulative earnings of the world's greatest companies.

Although the previously mentioned profit margins have varied, total earnings have increased nearly 4x since 2000.

Given this, doesn’t it make sense that stock prices would rise almost in lockstep (also about 4x) over that same period?

While general earnings, like profit margins, have fluctuated year after year, the long-term trend has driven stock prices.

Not surprisingly, this is one reason I encourage everyone to focus on the long term rather than the stock market's daily or even yearly fluctuations.

This rise in earnings didn’t happen overnight but over decades.

And I believe that this growth in earnings will persist in the decades ahead.

They certainly won't expand every year, but I expect them to continue rising over the long term.

Why?

Because businesses exist to serve their customers (who always seem to want more).

And the beauty of our capitalist society, for all its faults, is that competition encourages these businesses to provide the best possible product at the best possible price/value.

Generally, businesses that excel in this area will generate profits that enable them to continue innovating and investing in their operations, thereby sustaining their existence.

By extension, they’ll eventually become a more valuable enterprise, and their stock price will ultimately reflect this increase in value over the long term.

On the contrary, businesses that fail to earn a profit eventually fold.

While it’s not a flawless system, our business culture and stock market are admired globally for their profit-driven motivation to consistently meet the needs and desires of consumers everywhere.

It’s likely safe to assume that profit margins will eventually decline, but I believe we should concentrate less on what will happen next and more on the long term.

Thank you for reading, and don't forget to subscribe to the Stay Wealthy YouTube channel!

Stay wealthy,

Taylor Schulte, CFP®