Tuesday, November 24, 2009

More good news on corporate profits

Here's a 50-year history of corporate profits (adjusted, after-tax) as a percent of GDP. Besides noting the obvious, that profits relative to GDP have improved sharply this year and are above average, I think it's very important to note the following: Profits relative to GDP fell during the 1968-80 period, and this period also saw miserable performance from the stock market. Then profits rose relative to GDP from 1980 through 1998, and this marked one of the great bull markets in history. Profits fell relative to GDP from 1998 through 2002, and the stock market collapsed. Profits have risen sharply this year relative to GDP, and stocks have soared. I don't think these observations are coincidences. I do see a legitimate rationale for equity market gains.

This next chart shows my calculation of a PE ratio for the stock market, using NIPA after-tax profits as the source for the E, and the S&P 500 index (normalized) as the source for the P. Note that the ratio was ridiculously high just before the stock market collapsed in 2000-2002, while the current PE ratio is quite low by historical standards, suggesting that the market is quite conservatively valued. Again, another reason to be bullish on the prospect for equities.

Alert readers would be pointing out at this juncture that PE ratios calculated using GAAP profits are significantly higher today (north of 20) than this chart is suggesting. The reason for this is that GAAP profits are extremely depressed relative to NIPA profits, as this next chart shows. GAAP profits are traditionally much more volatile than NIPA profits due to the vagaries of corporate accounting practices, whereas NIPA profits are based on IRS data and adjusted to reflect "economic" profits. This chart further suggests that we are likely to see some exceptionally strong gains in GAAP reported profits in the next year or so, since NIPA profits generally lead GAAP profits.


alstry said...


Your charts look great....can you explain why tax receipts, including corporate tax receipts, sales tax receipts, and personal income tax receipts to practically every state in the Union are evaporating forcing local governments to face the worst fiscal crisis since The Great Depression........and the distress really has no geographical concentration?

The data seems to conflict these days and can be confusing when you have Governors making statements like this:

The state's "extremely precarious and worsening fiscal situation" necessitates the payment denials that the legislation would allow, he said. Mr. Paterson said Friday that the cuts could involve furloughs and layoffs of state employees, as well as delayed payments to schools, local governments, workers, health care and service providers. Payment reductions would exclude debt service and collective-bargaining obligations, as well as those expenses required under state and federal law.

"I want to make clear that this is not a cash flow problem that can be fixed with one-shorts or creative accounting," Mr. Paterson said. "This is a lack-of-cash crisis that threatens the financial stability of our state. Unless we take action, the state will run out of money."

Thank you.

brodero said...

Excellent article....

Cabodog said...


"Payment reductions would exclude... collective-bargaining obligations"

There you have it.

The balance of the statement by Mr. Paterson simply mimics what quick-responding corporations did 12-18 months ago. They got lean. They got rid of dead-weight money-sucking unproductive employees, leaving behind the cream.

It just takes our governments longer to wake up to the fact that they've become bloated, inefficient organizations.

Gene Prescott said...

There is a significant lag between the time corporations experience profits and cash is paid into the coffers of taxing authorities. These charts should ultimately be good news to government.

Scott Grannis said...

alstry: As Gene notes, you need to look to changes on the margin, where a lot of positive things are happening.

Michael Meyers said...

Scott et. al.

It seems to me that comparing corporate profits to GDP and US tax receipts is becoming more irrelevant every quarter... the reason being that many US based business have an ever increasing percentage of business overseas [e.g. for CAT it is 60%]. These foreign profits are not taxed till returned to the US, which is often unlikely. And given that the US has one of the highest corporate tax rates in the world, I'm sure that corporations are gaming the US tax system as best they can by allocating costs to their advantage across countries.


Scott Grannis said...

Yes, the U.S. desperately needs to lower its corporate income tax rate. It doesn't do anybody any good.