Some call this greed, others call it “quality of earnings.” Net profit margins can be extreme.
Written by Lim Hyun Soo and Segun OlakoyenikanEdited by ; William Baldwin
isDefinition: Net income divided by revenue. Why should investors care about this? Because it indicates a company’s ability to withstand adversity. Companies with high profit margins tend to have low fixed costs and strong balance sheets. Their businesses are more likely to hold up during a downturn.
According to FactSet, the average margin for stocks in the S&P 500 index is 11.6%. The table shows some exceptions: first, companies with fine margins (some chronically low, some temporarily low), and then there are companies with higher margins, such as Visa, Nvidia, and Microsoft.
Stocks from these three winners often appear in the portfolios of funds that chase so-called quality factors. “Quality” isn’t a precise term, but it generally reflects pricing power, high returns on assets and stable prosperity.Quality lovers are unlikely to get enamoured with commodity producers like Cleveland-Cliffs or International Paper, suppliers to industries known for price wars, such as American Airlines, or old-school retailers like Macy’s.
Some of those exorbitant profit margins are bound to shrink. Airbnb is getting a temporary boost from a negative tax bill, the result of carrying forward losses from years of struggling growth and emerging from the pandemic. Altria has a lot of pricing power (it’s hard for new cigarette brands to enter the market because of its advertising ban), but there’s no way to stop its customer base from eroding. Hut8’s revenues are as unpredictable as Bitcoin’s.
On the other side of the margin seesaw, there are a few companies that are poised to bounce back: Disney once boasted 5x margins and can probably overcome the current glut of streaming movies and sports programming; Dana has non-recurring losses that probably won’t happen again.
Profitability is a hot topic for investors and politicians alike. “A recent study found that roughly 54 percent of the increase in inflation is directly attributable to astronomical increases in corporate profit margins,” said Sen. Bernie Sanders of Vermont. “Profits for America’s largest corporations will exceed $3 trillion this year, and profit margins continue to grow,” Sen. Sherrod Brown of Ohio said recently.
Lawmakers are right to point to rising profit rates: Corporate profits, as a percentage of value added, have risen from 2.2 percent to 15.6 percent over the past half century, according to data from the Federal Reserve Bank of St. Louis.
Meanwhile, public outrage at corporate greed is misdirected. The usual targets of consumer ire — airlines, car dealerships, grocery stores — don’t usually enjoy big profit margins. Perhaps the next lecture on greed should be directed at vendors of vacation rentals, software packages, and artificial intelligence chips.
The table of extreme companies excludes flow-through companies (e.g., REITs) and loss-making companies.
Low net profit margins
High Net Profit
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