S&P profits soar as companies pass inflation on to customers

How to cope with the higher inflation sweeping the economy? For corporate America, the answer so far is simple: Raise prices.

Companies are charging more for everything from diapers to auto parts, more than covering their own higher costs. They’ve been so successful that analysts say big United States companies’ profit margins have never been higher.

As a result, quarterly profit reports from S&P 500 companies the last few weeks have blown past Wall Street’s expectations. That’s helping to support record high stock prices despite worries that valuations have shot too high and that the delta variant of the coronavirus could hurt the economy.

Consider meat producer Tyson Foods, which has had to contend with higher costs for grain to feed its chickens and other sources of inflation. Yet its profit still leaped 42 per cent in its latest quarter over the prior year.

A big part of that was because its pricing for chicken rose 16 per cent during the quarter.

“We’re just simply asking for fair market value for these products,” CEO Donnie King said.

Across the S&P 500, such moves mean companies appear to have held on to US$13 of profit for every US$100 they made in sales during the spring. That would be the highest profit margin for a quarter since FactSet began tracking the measure in 2008, and it’s well above the average of US$10.60 for the past five years.

With companies making more profit on every sale, and with higher overall sales on top of that, earnings for S&P 500 companies last quarter are on track to have roughly doubled from a year ago. That would be the strongest growth since the economy bounced back from the Great Recession. About 90 per cent of companies in the S&P 500 have reported their results for April through June.

This strength in earnings and profit margins is one reason strategists at Goldman Sachs recently raised their target for the S&P 500’s year-end level to 4,700, up from 4,300.

The coast is not clear, though.

Executives are talking more often about having to raise pay for their workers, rather than just higher prices for commodities. That kind of inflation can be more difficult for companies to mitigate.

Mentions of labour-related inflation jumped 107 per cent for the second quarter from a year earlier, according to BofA Global Research, which analysed conference calls that CEOs conducted with analysts following their earnings reports. That was a big jump from the prior quarter’s 12 per cent rise.

That may also be a reason why analysts are forecasting a slight squeeze on corporate profit margins during the second half of the year.

No one expects companies to keep doubling their profits. This past quarter was likely the easiest of the recovery to deliver such eye-popping year-over-year growth, because it came 12 months after the worst of the COVID-19 economic shutdowns.

But companies will need to keep delivering strong gains to justify the big moves their share prices have made. Stocks in the S&P 500 are trading at roughly 28 times the earnings-per-share they’ve delivered over the last 12 months. That’s a much more expensive valuation than they’ve been at historically.

If the US Federal Reserve slows its bond-buying programme and eventually raises interest rates, as much of Wall Street expects, current stock valuations would look even more expensive. Higher interest rates tend lower the price investors to pay for every US$1 in earnings a company delivers.

AP