Data Update 5 for 2022: The Bottom Line!
The proverbial bottom line for success in business is the capacity to deliver profits, at least in the long term. Even though we live in an age where user platforms and hyper revenue growth can drive company valuations, that adage remains true. In fact, questions about profitability seem to have taken center place again, not only because a market pull back is a reminder that growth, by itself, cannot deliver value, but also because there are still unresolved debates about how much damage the COVID crisis did to earnings power at companies, and whether this damage has been healed, as economies have opened up. In this post, I will look at corporate profitability, in all its different dimensions, and how companies across the globe, and across industries, measured up in the most recent years.
Earnings from LTM 2021, divided by revenues generated during that period |
- First, note that while less than 6% of the 47,606 firms in the sample have negative gross margins, the number is significantly higher for operating margins (43.1%) and net margins (47.3%).
- Second, while it is no surprise that gross margins are significantly higher than operating and net margins, the magnitude of the difference is striking; the median gross margin across all global companies in 2021 is 30.07%, but it melts down to a median operating margin of 5.67% and a median net margins of less than 4%. These margins vary widely across companies, and in the table below, we report on the statistics across sectors:
Buzzword | Profitability Effect | Reasoning |
---|---|---|
Powerful Brand Name | Higher operating profit margins, relative to peer group | Brand name allows you to charge higher price for the same products. |
Economies of scale | Operating margin improves as revenues increase | Costs grow at a slower rate than revenues |
Superior unit economics | High gross margins | Extra unit costs little to produce, relative to price. |
Strong competitive advantages | High return on capital, relative to peer group | Barriers to entry earn and sustain high returns |
Canny borrower | High return on equity, relative to return on capital | Benefits from difference between return on capital and after-tax cost of debt. |
Tax player | After-tax operating income is close to pre-tax operating income | Lower effective tax rate, across all income. |
Corporate Age = Years since founding |
All companies in S&P technology sector |
- Low Hurdle Rate ≠ Positive Excess Returns: The notion that lower interest rates, and the resulting lower hurdle rates that companies face, has been a boon for business is clearly not supported by the facts. If anything, as rates have decreased over the last decade, and costs of capital for companies hit historic lows, companies are finding it more difficult to earn returns that exceed their costs of capital.
- Good and Bad Businesses: It is
an undeniable truth that some businesses are easier to generate value
in, than others, and that a bad business is one where most of the
companies operating in it, no matter how well managed, have trouble
earning their costs of capital. Using the excess returns estimated from
2021, I estimated the excess returns (ROIC - Cost of capital) in 94
industry groups, and the ten "best" and "worst" industries, in terms of
median excess return, are listed below:
If you look at the worst businesses, there are a couple that show up every year, like airlines and hotel/gaming, where COVID exacerbated problems that are long term and structural. The airline and hotel businesses are broken, and have been for a long time, and there is no easy fix in sight. Biotechnology companies can claim, with some justification, that their presence on the bad business list reflects the fact that many in the sector are young companies that are a breakthrough away from being blockbuster winners and that they will resemble the pharmaceutical business (which does earn positive excess returns), in maturity. I am sure that there will be ESG advocates who will claim credit for fossil fuel and mining businesses that show up in the worst business list, but not only will their rankings change quickly if oil and commodity prices rises, but the best business of all, in 2021, in terms of delivering excess returns, is the tobacco business, not a paragon of virtue. While the technology boom has created winners in information and computer services, building-related businesses (from materials to furnishings to retail) and chemical companies also seem to have found ways to deliver returns that exceed their costs.Excess Returns, by Industry (US, Global) - Disruption's Dark Side: Among the bad businesses, note the presence of entertainment, a historically good business that has seen its business model disrupted, by new entrants into the business. Netflix, in particular, has upended how entertainment gets made, distributed and consumed, and in the process, drained value from established players. While this is a phenomenon that has played out in business after business, over the last two decades, there are a couple of common themes that have emerged in the excess return data. Disruption, almost invariably, leads to lower returns for the status quo, i.e., the disrupted companies in the business, but disruptors often don't end up as beneficiaries. Consider the car business, where ride sharing has destroyed cab and traditional car service businesses, but Uber, Lyft, Didi, Grab and Ola all continue to lose money. Put bluntly, disruption is easy, but making money on disruption is difficult, and disruption creates lots of losers, but does not necessarily replace them with winners.
إرسال تعليق