The Pressure on Margins

Here’s a look at a chart that shows one of the most important dynamics of this market. Namely, corporate profit margins have been stretched about as far as they can go.

The blue represents the trailing four-quarter earnings of the S&P 500 and it follows the right scale. The red line is the trailing four-quarter sales and it follows the left scale. The two lines are scaled at a ratio of 10-to-1. That means that if the lines cross, profit margins are exactly 10%.

You’ll notice that the blue line closes the gap later in the cycle which means that profit margins rose. In this cycle, profits have risen considerably but sales haven’t grown very much. You can’t cut costs indefinitely. At some point, companies need to see greater sales growth in order to boost earnings. We’re currently right at the spot which has historically been the upper limit of profit margins. That doesn’t mean we can’t go higher, but it would be unprecedented.

Posted by Eddy Elfenbein on October 22nd, 2012 at 2:22 pm

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