Sunday, August 6, 2017

Economics: Why Do Company Earnings Grow More Than 10% In A Sluggish Economy?

(Drivebycuriosity) - The economy may be sluggish, but companies are doing well. The big US companies, which are represented in the SP 500, reported fast growing profits for the second quarter 2017. "Total earnings for these companies are up +11.6% from the same period last year on +5.6% higher revenues", reports the financial information service Zacks (zacks).

So, company profits are rising much faster than the general economy, which is just growing about 2% annually (GDP growth). How do they do that?

I think there are at least 3 reasons for that:

Company earnings are rising faster than the national incomes (GDPs) because corporations are getting more efficient & more productive over time - thanks to learning processes and the technological progress. Companies are learning organisms because they are managed by humans who are continuously improving themselves and their companies. During the recession 2008 companies had restructured and reduced costs significantly in order to survive. Now they are more fit & more efficient than before.

Company earnings are also boosted by automation.  Since the early 18th century (the first industrial revolution) the technological process has been enabling companies to produce more goods & services with the same amount of employees. More and better machines are doing the work of people which translates into lower costs, higher profit margins and climbing earnings.

It seems that this process is accelerating again and we are at the begin of new industrial revolution. We are experiencing a rapid advance of information technology, meaning combinations of computers, smartphones, Internet and other digital systems. Software - which is increasingly Internet connected and uses more and more the cloud (access to huge external data centers) - organizes the whole business: Creating new products, inducing machines to run more efficient, finding cheap suppliers, manage customer relations and so on. Car producers and many other manufacturers are increasingly using robots and similar machines to reduce their costs. Companies are also beginning to use 3D-printers to become more cost efficient and flexible.

Company profits are also boosted by the rise of the emerging markets. China, India & Co. create additional markets. Therefore companies can produce more which translates into shrinking average production costs (economies of scale). Emerging markets also deliver cheap supplies (most computers, tablets & smartphones are manufactured there) which reduces the production costs further.

I believe that the learning process will continue and will translate into a long term trend of fast rising company profits, the engine of the stock market rally. Investors might forget about politics and focus on what really counts.

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