Tags: gdp | economy | profit | investors

Lots of GDP Producing Lots of Profit

Lots of GDP Producing Lots of Profit
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Tuesday, 05 December 2017 10:46 AM Current | Bio | Archive

Profits I: Record Highs. The National Income & Product Accounts (NIPA) reports preliminary quarterly corporate profits along with the second revision of GDP. For Q3, that transpired on November 29, when real GDP was revised to 3.3% from the preliminary 3.0%. That solid gain followed Q2’s solid gain of 3.1%. Both nominal and real GDP continue to rise into record-high territory. Not surprisingly, NIPA profits data are doing the same. Let’s review the cornucopia of corporate earnings data compiled in the NIPA:

(1) Aggregate book profits. Pretax corporate “book” profits, i.e., as reported to the IRS, rose to a record high of $2.34 trillion (saar) during Q3 (Fig. 1). That’s up 7.3% y/y. Corporate profits taxes totaled $476 billion (saar) (Fig. 2). Melissa and I have been noting of late that there is a big difference between the NIPA profits tax series and the actual corporate tax revenues collected by the IRS. The former has been consistently higher than the latter (Fig. 3 and Fig. 4).

We are still looking into the reasons for this divergence. It may be that the NIPA, which are focused on measuring current production, may not reflect all the deductions used by companies to lower their actual tax bill. There may also be some issues with respect to how profits earned abroad are treated.

In any event, after-tax book profits rose to a record high of $1.86 trillion (saar) during Q3, up 10.0% y/y (Fig. 5). That solid gain was foreshadowed by the earlier release of S&P 500 aggregate reported earnings, which rose 11.4% y/y through Q3. By the way, S&P 500 aggregate reported earnings tends to account for roughly 50% of after-tax book profits (Fig. 6).

(2) Aggregate and industry cash profits. Again, the NIPA focus on current production since the accounts are designed to measure GDP, which is the broadest measure of the economy’s current production. Therefore, the NIPA adjust profits to eliminate inventory profits and profits related to the accounting for the historical cost of depreciating capital goods and infrastructure. The inventory valuation adjustment (IVA) accomplishes the former, while the capital consumption adjustment (CCAdj) does the same for the latter (Fig. 7).

These two adjustments haven’t changed the underlying story told by book profits. After-tax profits from current production (i.e., on a cash-flow basis) rose 7.7% y/y through Q3 to $1.74 trillion (saar), matching the previous record high during Q4-2014. This series was depressed during 2015 by the energy-led profits recession.

The NIPA show pretax profits from current production derived from domestic and foreign operations. Domestic nonfinancial and financial industries’ profits remain on uptrends but below recent highs (Fig. 8). On a pretax and current production basis, the NIPA series for net profits from the rest of the world has been stuck around an annualized $400 billion rate since the start of the current economic expansion (Fig. 9). However, gross profits receipts from overseas rose to a record high of $733.3 billion (saar) during Q3.

(3) Dividends and retained earnings. The NIPA data show that dividends paid by all US corporations has been flat at a record high around an annualized $1.0 trillion since Q3-2014 (Fig. 10). Retained earnings (i.e., undistributed corporate profits on a cash flow basis including the IVA and CCAdj) has recovered in recent quarters from the energy-led profits recession (Fig. 11). It totaled $740 billion (saar) during Q3, still 13.0% below the record high during Q3-2010.

(4) Cash flow. Nevertheless, corporate cash flow rose to a record $2.38 trillion (saar) during Q3 (Fig. 12). This series is the sum of retained earnings and tax-reported depreciation, which rose to a record $1.64 trillion last quarter. Previously, Debbie and I have noted that while many corporations have been buying back their shares, there has been plenty of cash flow left over to fund capital spending. Besides, quite a bit of the buybacks seems to have been funded by borrowing in the bond market.

(5) Profit margin. While Thomson Reuters’ measure of the S&P 500 operating profit margin was at a record high of 10.8% during Q3, the comparable NIPA after-tax profit margins relative to GDP remain below cyclical highs, but are still high nonetheless (Fig. 13 and Fig. 14). The Q3 margin was 9.5% based on book profits and 8.9% based on cash profits. In any event, Joe and I have observed that following the Trauma of 2008, corporate managements have seemed to be much more focused than ever before on maintaining as high a profit margin as possible.

(6) Bottom line. The bottom line is that US corporations are in great shape.

Profits II: Proprietors’ Income. Almost always ignored in discussions of corporate profits is proprietors’ income, which is included in personal income on a pretax basis including the IVA and CCAdj. It is up 2.7% y/y and in record-high territory. A comparison with pretax corporate profits, also including IVA and CCAdj, shows that proprietors’ income recently has approximated 60% of corporate profits (Fig. 15 and Fig. 16). Here are some definitions from the NIPA:

(1) “Nonfarm proprietors’ income measures the income, before deducting income taxes, of sole proprietorships, partnerships, and other private nonfarm businesses that are organized for profit but that are not classified as corporations. Sole proprietorships are businesses owned by a single individual. Partnerships include most associations of two or more of: individuals, corporations, noncorporate organizations that are organized for profit, or of other private businesses. Other private businesses are made up of tax-exempt cooperatives, including credit unions, mutual insurance companies, and rural utilities providing utility services and farm marketing and purchasing services.”

(2) “Unincorporated businesses … are able to move assets freely between business and personal accounts with little, if any, reporting requirements, and tax liabilities are not separated between unincorporated businesses and their owners. In fact, the income of unincorporated businesses is generally reported on individual income tax returns; while compensation paid to employees is separately reported, the income of the business is not distinguished from the labor of the business owner and therefore reflects the incomes that accrue as a result of the owner’s own labor and entrepreneurship. Similarly, dividend and interest incomes are separately reported but do not distinguish between business and personal receipts.”

(3) “Reflecting the concepts of national economic accounting, nonfarm proprietors’ income in the NIPAs is defined as that arising from current production.”

Obviously, the wellbeing of small unincorporated businesses is an important contributor to the wellbeing of the overall economy. Corporations, partnerships, and sole proprietorships all are likely to increase their payrolls and expand their capacity when their profits are rising. They are likely to retrench when their profits are falling.

We soon should find out whether the Republicans’ tax reform plans include substantial benefits, not only for corporations but for other businesses as well.

Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.

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The bottom line is that US corporations are in great shape.
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2017-46-05
Tuesday, 05 December 2017 10:46 AM
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