Costs are increasing for businesses. Why the margins are better than before Covid-19.

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A scene at the New York Stock Exchange.


Rising business costs have recently made markets nervous. But the current earnings season has shown that, overall, companies are still very profitable.

Companies have indicated that the higher costs are a valid concern, and the data backs it up. Some companies – 3M (ticker: MMM), for example – have said they may not be able to raise prices enough to offset the higher costs, which have emerged as companies rush to purchase supplies. in times of shortage. The producer price index has steadily risen faster than the consumer price index since early September, indicating that companies pay more for what they buy, but do not pass full costs on to the market. public.

For a period in September, the consensus call for third-quarter aggregate earnings per share for the S&P 500 was down nearly 1% from its previous high. Concern for profit margins was part of the equation. The

S&P 500

fell just over 5% from its all-time high in early September to the bottom of its October 4 decline.

But the third quarter earnings season shows that these worries are not taking a big hit on earnings. The overall result per share of

S&P 500

companies has so far exceeded expectations by around 10%, according to Credit Suisse. Just a few weeks ago, that figure was only 4%.

High profit margins have been one of the drivers of earnings outperformance, an indication that higher costs are not yet an issue. Of the 109 S&P 500 companies that released third quarter results from early September until Oct. 20, the overall pre-tax profit margin was 17.9%, according to Wells Fargo. Granted, that’s a hair’s breadth less than the 18.1% seen in the second quarter, when demand skyrocketed beyond what the supply chain could handle. But it remains above the pre-tax margin of 15.5% observed in the third quarter of 2019, before the pandemic.

More encouragingly, the higher overall profit margin is occurring across the board. Of course, financial companies’ margins improved compared to Q2 and Q3 2019 due to industry-specific banking trends. But for the 80 non-financial corporations in the Wells Fargo sample, the aggregate pre-tax margins rose to 13.2%, above the 12.8% observed in the second quarter and above the 12.4% observed in the third quarter of 2019.

One of the main reasons is that consumer demand has been so strong that many companies can effectively raise their prices. “The bottom line: demand and prices are strong and margins remain resilient,” writes Christopher Harvey, head of equity strategy at Wells Fargo.

None of this comes as a surprise, historically. Companies often record higher profits during times of inflation. The correlation between the direction of industrial commodity prices and that of the S&P 500’s earnings estimates for next year has been close since 2000, according to data from The Leuthold Group.

Remember that higher prices are partly a function of higher demand. “Company profits may actually be higher, in part because of higher inflation,” writes Jim Paulsen, chief investment strategist at The Leuthold Group.

The S&P 500 has risen nearly 6% since October 4, with shares from a large group of sectors participating in the rally.

Inflation is always a risk. If shortages and shipping problems persist, inflation could eventually cause consumers to cut back on spending. For now, however, the companies are still very profitable.

Write to Jacob Sonenshine at [email protected]

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