High profit margins, debt, money flows, investment
Financial Times takes a look at the question of how high profit margins are obtained in a high unemployment and high debt economy:
The key to the first question is US profit margins, which are still at or around record highs. At some point, logic suggests they will start reverting to the mean. And, aside from events in the eurozone and elsewhere, wringing out more productivity is a finite process. There is only so much juice in the lemon. In the long run, lack of investment must surely take its toll. According to Smithers & Co, official figures show the proportion of US domestic corporate cash flow devoted to capital investment at record lows of about 57 per cent. This compares with an average of 77 per cent over the past 60 years. So where has the cash gone? To shareholders, mainly. In the second half of last year, dividends and buybacks by US corporations came to almost exactly the same as capital investment, at just over $2tn. As recently as the early 1990s, spending on investment was four times the amount handed to shareholders. The ratio has been dropping steadily ever since… …it is worth noting that even credit analysts these days tend to measure debt in relation to cash flow rather than assets. If corporate margins are indeed under threat, that is self-deluding. …The money will have come from their own immense cash piles. But US companies still have net debt – after deducting that cash – equal to perhaps 40 per cent of their equity.
This means that corporate and dividend tax rates are too low. When taxes are higher, it pays to invest money in company growth, thereby avoiding taxes, rather than extract capital for shareholders.
This means that corporate and dividend tax rates are too low. When taxes are higher, it pays to invest money in company growth, thereby avoiding taxes, rather than extract capital for shareholders.
This means that corporate and dividend tax rates are too low. When taxes are higher, it pays to invest money in company growth, thereby avoiding taxes, rather than extract capital for shareholders.
What this suggests supports what is increasingly noticeable in an increasing number of financial reports not just in the US; that for 20+years, funders (mainly banks in Europe & UK) have been able to essentially smooth cycclical operating cashflow with cashflow from investment & financing activities. This enabled weak operating or management performance to be (implicitly) hidden as banks took on the role of society’s capital allocators. However, it turns out that this process benefited the remuneration of both financial and non-financial corporate execs. That ‘virtuous’ circle has now been broken and the rest of society is picking up the economic tab.
This article supports what is increasingly noticeable in many financial reports not just in the US; that for 20+years, funders (mainly banks in Europe & UK) have been able to essentially smooth non-financial corporates cycclical operating cashflow with cashflow from investment & financing activities. This enabled weak operating or management performance to be (implicitly) hidden as banks took on the role of society’s capital allocators. However, it turns out that this process benefited the remuneration of both financial and non-financial corporate execs. That ‘virtuous’ circle has now been broken and the rest of society is picking up the economic tab.
I think its technology and a global marketplace that are driving the higher margins.
A company has the entire world to sell to, and can make enough sales across countries to be profitable despite economic problems in many countries. Second is modern tech companies are a bigger portion of our economy. Technology has lower capital costs than many older line businesses. There is a lot of profits per employee. Facebook has 3,500 employees but an intial public value of $100 billion, and high profits per employee. Apple, etc… You can start an app with just a handful of people and have hugely profitable margins.
One can start a company with very robust enterprise tech using the cloud, so you do not have to build expensive infrastructure or data centers or add tons of IT staff. Thi stuff is incredible scalable. You can also sell stuff digitally music, books cutting out materials, just-in-time inventory, and the list goes on. The way my company allocates investmnet has changed dramatically because of tech. No more expensive facilities, when people can work from home using the internet.
This means that [corporate financial leverage/debt levels] are too [high]. When taxes are higher, it pays [borrow more money], thereby avoiding taxes, rather than extract capital for shareholders.
BillB wants to drive corporate reinvestment decisions with tax policy. That’s a pretty good way to get bad investments. It’s also a pretty good way to introduce more net debt onto corporate balance sheets so that they can protect profits by paying interest expense. Where will that debt come from? Banks and or bondholders. If banks are lending more to corporates that will expand bank balance sheets as well, further increasing leverage in the system and increase aggregate bank profits at the expense of non-bank profits. Not that this hasn’t been tried before.
“When taxes are higher, it pays to invest money in company growth, thereby avoiding taxes, rather than extract capital for shareholders.”
So what do you think happens when shareholders get capital? They burn it or something? Or perhaps reinvest it again in some other company? Possibly even in some new company?
Which is, of course, where we’d like investment to be taking place. Economic growth and productivity gains come not so much from extant companies getting better but from entry and exit from the market by companies. Which means that we’re really quite happy to see the returns from earlier investments being paid out by mature companies which then get recycled into a series of new investments in new entrants.
If we were being sensible there would be no taxes at all on dividends: as long as they were reinvested in other or new projects.
Tim
“as long as they were…”
and what do you do when they are not?
tim
with all respect, your point of view is too narrow. i can’t argue that you are wrong. i can argue that if a country does not take care of “the least of these” accumulated losses, not to say humanitarian considerations, will eventually foul the machinery
and your investors will not be able to invest in anything real, forcing them to “invest” in pure gambling… with the eventual result that we have seen.
High corporate profit margins are currently largely supported by the government deficit. This stems from Kalecki’s Profit Equation, which I highlight here: http://bubblesandbusts.blogspot.com/2012/03/forthcoming-profit-recession.html
If the deficit decreases next year prfot margins will likely drop as well.