Stahl: Weakness Of 2002 Compared To 2011 – A Case StudyVW Staff
The subject for the Musings section is the table below, which lists the largest companies in the S&P 500, excluding the financials.1 The purpose of this examination is to compare the net profit margins of these companies as they existed in 2002 with those from the end of 2011. The idea is to compare a weak economy with another weak economy, separated by almost a decade. Aspects of economic weakness notwithstanding, the margins as we found them in 2011 were far higher than they were in 2002.
The obvious example is Apple Inc. (NASDAQ:AAPL), whose profit margin was 1.1% in 2002 and rose to 23.9% in 2011, an increase that explains much of the stock price performance. Even a company like Microsoft Corporation (NASDAQ:MSFT), which in 2002 had an 18.9% net profit margin, increased its net profit margin to 33.1%. In the same period, Proctor and Gamble went from 10.5% to 14.0%, Chevron from 1.1% to 10.6%, and IBM from 6.6% to 14.8%.
The 22 companies on the list, irrespective of their margins, comprise about one-third of the market value of the S&P 500. To a large extent, they determine the profit margin of the S&P 500 and, to a very large extent, what the performance of the S&P 500 will be. Although most of the companies on the list had higher margins in 2011 than in 2002, eight were lower: General Electric Company (NYSE:GE), AT&T Inc. (NYSE:T), Johnson & Johnson (NYSE:JNJ), Pfizer Inc. (NYSE:PFE), The Coca-Cola Company (NYSE:KO), Merck & Co., Inc. (NYSE:MRK), Verizon Communications Inc. (NYSE:VZ) and PepsiCo, Inc. (NYSE:PEP). Of these eight companies, three—Merck, Pfizer, and Johnson & Johnson—are in the health care field, where it’s very difficult to imagine margins increasing in any material manner given current cost containment pressures. It’s also hard to imagine the 14 companies that generally show higher—and in some cases very much higher—profit margins increasing those margins beyond the current level. So, that’s a total of 17 of the 22 companies for which it’s hard to imagine profit margins increasing. Of the eight companies with lower margins, Coca-Cola had a modest decline in profit margin, from 20.3% to 18.4%, between 2002 and 2011. On an absolute level, however, that’s still very high, so it’s hard to imagine Coca-Cola meaningfully increasing its profit margins. That brings us to18 out of 22 companies with little prospect of increasing their profit margins.
Another of the companies, PepsiCo, has been trying for a decade to increase its profit margins with a notable lack of success. In 2002, its profit margin was 11.6%, and in 2011 it was 9.7%. All sorts of remedies have been proposed, one of which is a spin-off of the Frito-Lay snack food business. It’s not entirely clear that the Pepsi management is very enthusiastic about that option, nor is it clear that it would achieve the desired result. In any event, that spin-off seems to be the consensus wisdom of what needs to be done to make Pepsi’s margins higher. PepsiCo only represents 0.82% of the S&P, so whatever happens to the company in a positive sense will not radically influence the S&P 500.
General Electric also experienced a decline in its profit margins. In the current climate, it must run GE Capital with much less leverage than it did historically for reasons that are self-evident. It is no surprise, therefore, that General Electric Company (NYSE:GE)’s profit margins in 2011 were lower than in 2002. GE Capital plays a tremendous role in the revenues of the nonfinancial services businesses, because it provides financing for them. It contains tremendous leasing businesses that benefit when the company is able to acquire capital at a very low cost basis and in a very aggressive manner, because it can then offer favorable financing terms. However, since GE must run GE Capital with a significantly lower leverage ratio that in the past, it is difficult to imagine much higher margins for the company.
Two companies that offer potential for margin improvement are AT&T Inc. (NYSE:T) and Verizon. AT&T had a net profit margin in 2002 of 17.2% and Verizon had a profit margin of 6.8%. In 2011, they were 3.1% and 2.2%, respectively, which are very slender margins. The obvious way that the AT&T and Verizon margins could be improved would be if they could achieve some sort of economy in the wireless space, since the wire line business is gradually declining. In the fullness of time, and that might be a quarter century, the wire line business might eventually erode to zero.
Via Horizon Kinetics