Corporate profits

Cost pressures are not reducing business profits yet

Rising costs are not about to end the corporate profit party. But not all businesses will be able to continue celebrating.

With the third quarter over, companies will soon begin reporting their results. Overall, analysts expect them to be very good, with earnings per share 29.6% higher than a year earlier for S&P 500 companies, according to estimates collected by Refinitiv .

The actual earnings per share will almost certainly be better. Analysts tend to downgrade their forecasts, and third-quarter estimates look unusually low. S&P 500 earnings are expected to show a sequential decline of around 7% from the second quarter, when the most typical seasonal pattern would be for them to increase a bit. Additionally, while the US economy may have slowed somewhat in the third quarter compared to the second, it still appears to have grown, while the global economy has grown as well.

With supply chain bottlenecks driving up material, equipment and shipping costs, and the challenge of finding workers who send higher labor costs, you can see why analysts might be a little more cautious about their estimates. But a glance at some of the economic data suggests that, at least overall, profit margins are not yet under pressure.

For example, figures from the Department of Labor show that wholesale prices for finished consumer goods, excluding food and energy products, rose 4.7% in August from a year earlier. It was the biggest gain in over a decade. But the prices paid by consumers for goods excluding food and energy rose 7.6% year on year in August. The two sets of data are not strictly comparable, but it does appear that companies may be able to pass on their costs.

Wages are also on the rise. In the first two months of the third quarter, an aggregate measure of the Ministry of Labor’s income rose 1.8% from the second quarter. But since this is much slower than the pace of overall economic expansion plus inflation, it seems unlikely to affect business results. Likewise, a measure constructed by UBS strategists indicates that the prices charged by S&P 500 companies are rising faster than their wages.

Yet for some companies, the good times are probably over. Passing on the higher costs is not something that all businesses can do easily. If they are selling something for which there are cheaper substitutes, such as a brand name with little differentiation from private label alternatives, it might not be that easy to charge more. The same goes for optional items that people can easily do without, or categories that people just expect to stay cheap, like pizza.

In addition, in some areas the cost pressures are more intense than in others. Wage growth for workers with lower-paid jobs has grown much faster than for those with higher wages. For businesses that tend to hire low-wage workers, like restaurants (which also have to deal with higher food costs), this isn’t ideal.

For the most part, third quarter earnings reports should look very good, but some investors could still have a bad experience.

The number of semiconductors in a modern car, from ignition to brake system, can exceed a thousand. As the global chip shortage continues, automakers from General Motors to Tesla find themselves forced to adjust production and rethink the entire supply chain. Illustration / video: Sharon Shi

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Appeared in the October 1, 2021 print edition under the title “Costs Still Not Matching Company Profits”.

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