From Advisor Perspectives:
Companies around the world enjoyed especially high profit margins in late 2012. But can this trend be maintained or is profitability poised for a collapse that might threaten stocks this year?
Toward the end of 2012, net profit margins of US companies reached historic peaks of 7%, about 140 basis points above the 15-year average. International companies also posted high margins of about 6%. Globally, net margins are about 24% higher than the annual average over 15 years. However, questions are being asked after margin expansion stalled during the third quarter of 2012.
In my last blog, I explained why weak pricing power—if it persists—could make it harder for global companies to meet earnings expectations this year. Despite meeting lowered consensus estimates in recent reporting seasons, pricing power remains scarce and companies have generally lowered their earnings guidance for 2013.
Still, profit margins are complex. To solve the profitability puzzle, we dissected global data on net profit margins to find out whether they are predestined to revert from record highs to long-term averages and to identify vulnerable sectors or regions. This is the most important issue affecting future earnings growth and it determines whether equities are attractive in the longer term.
First, we looked at EBITDA margins, which capture the pre-tax benefits of pricing, leverage, productivity and outsourcing. We found that the increase in EBITDA margins for nonfinancial companies accounted for only 20% of the higher profitability. Most of the higher net margin came from lower depreciation, lower taxes and lower interest costs (Display).Historically, EBITDA margins were adversely affected by a collapse in demand, higher labor costs and prices of raw or intermediate materials. Generally, we don’t expect developed economies to face a recession or significant inflationary labor pressures in 2013 that would undermine profitability....MORE
