In this world of Egyptian riots, massive debts, soaring commodity prices, high jobless rates, depressed housing prices and whatever else your morning newspaper can add to the list, it’s refreshing to realize that the stock market dances to a different ipod. While the bears focus on the three Ds – Debt, Deflation and Depression – they ignore the three prosperous Ps: Profits, the mother’s milk of corporate America, fueled by rising Production (revenues) as magnified by increased Productivity. As this earnings season enters its home stretch, let’s examine all three components to see how they are fueling this rising stock market.
Step 1: Rising Profits
With over 76% of S&P 500 companies reporting their fourth quarter 2010 (4Q’10) results so far, S&P earnings are up 39.9%, far above analysts’ consensus expectations of +31%. Full-year 2010 earnings will rise by a spectacular 44%. Analysts currently expect 14.1% earnings growth in 2011 – a healthy double-digit gain, but nowhere near the 2010 pace, due to more difficult year-over-year comparisons. But we’ve already seen eight straight positive quarterly earnings surprises, so maybe 2011 will surprise analysts, too.
During these past eight quarters of positive earnings surprises, the skeptics have kept reminding us that corporate revenues (top-line growth) have lagged earnings (bottom-line growth), since this earnings surge is primarily due to corporate cost cutting – laying off workers and down-sizing sales goals. The skeptics remind us that cost cutting can’t continue forever. Only so many costs can be cut before the accountants slice into bone and tissue rather than fat. But the skeptics are in for a surprise: Revenues are rising, too.
Step 2: Surging Revenues
Fourth-quarter S&P 500 revenues rose 9.4% (year over year), far above analyst expectations of 7%. The details of GDP data reflect this surge. Based on “final sales” (GDP minus business inventories), the U.S. economy grew at a sizzling 7.1% rate last quarter – the fastest pace since 1984. That’s more than double the Commerce Department’s “flash estimate” of fourth quarter GDP (at 3.2%), a figure depressed by lower government spending (a positive trend) and severely depleted inventories due to rising retail sales.
According to economist Ed Yardeni, analysts’ revenue forecasts are now rising faster than their earnings forecasts. In the last three months, he said that nine out of 10 sectors saw rising 2011 revenue forecasts, while only six of 10 sectors saw their earnings forecasts move higher. We’re apparently moving from an earnings-driven market to a revenue-driven market. Bloomberg reported this week that Q4’10 revenues have beaten consensus estimates by 2.2%, which is a large number when you’re talking about a major macro-economic component of GDP. Bloomberg estimated that total revenue for S&P 500 companies could rise by 7.5% this year, the best rate since 2007, setting a new all-time high in absolute-dollar terms.
Step 3: Record-High Productivity
Now we move to the most important (and least reported) component of corporate profitability – the art of getting more done with less, or “productivity.” Technology helps produce more with less and streamlined work flows reduce unit labor costs. Productivity explains how profits and revenues can return to their peak 2007 levels with 7.1 million fewer workers. Productivity explains why businesses have been able to stockpile trillions of dollars in cash while expanding profit margins. Analysts now expect the S&P 500 profit margin to rise from 9.0% in 2010 to 9.6% this year and then 10.3% in 2012, and 11.0% in 2013. While our governments sink deeper into debt, U.S. corporations are beginning to resemble Swiss banks.
Here are some highlights of the Great American Productivity Surge over the last two calendar years:
Productivity grew 3.6% in 2010 after rising 3.5% in 2009 – the best two years since 2003.
Manufacturing productivity rose 6%, the best year since 2003 and triple 2009’s 2% growth.
Unit labor costs fell 1.5% in 2010 and 1.6% in 2009, the first back-to-back declines since 1960.
Manufacturing unit labor costs fell by 4.5% in 2010, the largest decline ever recorded.
While cost-cutting has its limits and profit margins can’t climb to the sky in a world of tight competition, productivity can keep rising. Last week, economist Ed Yardeni wrote eloquently about the philosophical case for ever-rising productivity: “Productivity has been growing ever since humans discovered the power of the division of labor to increase prosperity for everyone. Productivity can grow forever.”
Alas, the missing link in this equation is JOBS – the key lagging indicator, the final piece of the economic jigsaw puzzle to fall into place. Profitable companies can certainly afford to hire more people now, but they aren’t hiring enough to get the jobless rate under 9%. Maybe companies aren’t sure yet about their newly pro-business President. For two years, business was berated by Washington, so they may be slow to warm up to the new Obama. But with Congress disciplining the President’s previous spending and regulatory appetites, perhaps the biggest surprise of 2011 might involve creating 2-3 million net new jobs.
P.S. Speaking of the rising productivity in American businesses, let’s take a DRIVE down memory lane.
Let us Pause to Celebrate the Centennial of the Self-Starter!
Starting a car a century ago was a major aerobic event, with several turns on an unforgiving engine crank. In fact, the Ford Model T crank starter caused several injuries, plus needless sweat and hassle, not a very romantic start to a night on the town. But a century ago today, on February 17, 1911, the first self-starter was introduced to the top-line GM line, the Cadillac. The electric self-starter was invented by two noted GM engineers, Charles Kettering and Clyde Coleman. (Kettering also invented ignition systems, lacquer finishes, anti-lock brakes and leaded gasoline. Prior to his GM career, he also invented the electric cash register.) The self-starter soon gave GM a key competitive advantage when challenging Ford’s Model T.
GM’s technological innovation came under the guidance of its founder, William Crapo Durant (1861-1947), but market leadership is a movable feast: You snooze, you lose. A quarter-century later, Durant filed for personal bankruptcy on February 8, 1936. Biographer Dana Thomas called Durant a man “drunk with the gamble of America. He was obsessed with its highest article of faith, that the man who played for the steepest stakes deserved the biggest winnings.” Durant’s gamble at GM was to “build an empire of cars for every purse and purpose.” In just three years, at the dawn of the 20th century, Durant bought Pontiac, Oldsmobile and Cadillac. He even attempted to buy Ford. He later added Chevrolet. Later in life, Durant started Durant Motors, then he opened a bowling center and a supermarket, but he died broke.
At the same time of Durant’s bankruptcy, the next great “Model-T” multi-million-seller was being built in Germany: In early 1936, Ferdinand Porsche built the first Volkswagen, on orders from Adolph Hitler – to make an affordable car for the German people (Volkswagen = people’s car): 36 years later, on February 17, 1972, the 15,007,034th Volkswagen Beetle rolled out of the VW factory in Wolfsburg, Germany, topping the Ford Model T’s 22-year production record to become the most popular car model in history.
Two More Car Giants Born This Week
On February 16, 1852, Henry and Clement Studebaker (the oldest of five Studebaker brothers) founded the H & C Studebaker company – a blacksmith and wagon building business in South Bend, Indiana. Over time, their popular wagons eclipsed the blacksmith business. Then, with the advent of the horseless carriage in 1900, Clement Studebaker converted Studebaker to car manufacturing a year before his death in 1901. After his death, the company became one of the largest independent automobile manufacturers.
Enzo Anselmo Ferrari was born in Modena, Italy on February 18, 1898. After fighting in World War I, in which he lost both his brother and father, Ferrari became a professional race driver. In 1920, he joined Alfa Romeo, and in 1929 founded Scuderia Ferrari, a racing club that by 1933 grew into the race-car division of Alfa Romeo. Then Ferrari left Alfa Romeo in 1940 to form his Avio Costruzioni Ferrari.
Ferrari’s factory was bombed often during World War II. Production was halted, but he persisted with his design work. In 1949, a Ferrari won the 24 Hours at Le Mans, Europe’s most rigorous automobile race. Before Ferrari died at age 90 on August 14, 1988, Ferrari cars had won 25 world titles and over 5,000 races. Nearing death, Ferrari demanded that his engineers create the finest sports car in the world, the F40 in 1987. It had a top speed of 201 mph and went 0-to-60 in 3.5 seconds. What a way to go, Enzo!