Haver Analytics
Haver Analytics
Global| Dec 12 2019

Profit "Inequality"---- Is It Possible That S&P 500 Companies Make Money & No One Else Does?


Inequality has been used to describe the widening gap between household income and wealth. Yet, is it also appropriate to use "inequality" as a way to describe the growing and unexplained gap between the earnings of S&P 500 companies [...]

Inequality has been used to describe the widening gap between household income and wealth. Yet, is it also appropriate to use "inequality" as a way to describe the growing and unexplained gap between the earnings of S&P 500 companies and everyone else? Appropriate or not there is something unusual at work with the profit data, as it appears the only firms making any money nowadays are those in the S&P 500.

According to the Bureau of Economic Analysis (BEA), in Q3 2019 the annualized after-tax operating profits of all US companies, large and small, public and private, totaled $1.881 trillion. That represented an increase of approximately $220 billion from the level of after-tax operating profits recorded in 2015.

Over the same 4-year period, after-tax operating profits for S&P 500 companies increased from $885 billion to an annualized rate of $1.327 trillion in the third quarter of 2019, an increase of $442 billion.

Its possible to guesstimate the after-tax earnings of non-S&P 500 companies by simply subtracting the S&P 500 after-tax operating earnings from the aggregate GDP profit number. The residual after-tax profits –an estimate for non-S&P 500 companies---comes to $555 billion in Q3 2019, down sharply from the $779 billion recorded in 2015.

The key takeaway here is that over the past 4 years S&P 500 companies after-tax profits increased 50%, while the earnings of everyone else recorded a decline of roughly 30%.

How can that possibly be an accurate picture of the earnings of all the companies operating in the US? According to the Internal Revenue Service (IRS), there are more than 6 million firms operating in the US. Since the start of 2015 US firms has added nearly 12 million workers to their payrolls ---of which over 80% of the new jobs occurred at non-S&P 500 companies. It’s just not plausible that firms would be adding working and continue to lose money at the same time.

Now it must be noted that the comparison of operating profits is based on data from two different sources. Total corporate profit data comes the GDP report and the primary source is the tax-accounting records companies provide to the IRS. S&P 500 companies report their earnings on a financial accounting basis. The key differences between the two accounting frameworks reflects timing of when some receipts and expenses are recorded as well as the fact that capital gain income is excluded from the GDP measure but can be included in S&P reported profits.

Also, the estimate of S&P 500 profits represents an aggregated sum of company earnings reported on a per share basis. So a change in the number of shares outstanding has the potential to influence the numbers and skew the comparisons of the reported and estimated profit numbers.

Nonetheless, it worth pointing out that in the past 30 years only during the dot.com boom of the late 1990s did a similar profit picture occur; that is, reported earnings of the S&P 500 increased over a span of few years, while the estimated profits of all other companies tanked. And that apparent "inequality" in profits lead to a false narrative around corporate profitability, record high P/E multiples and an eventual crash in equity prices.

It is impossible to say with any certainty what factors are causing the gap between the reported earnings of the S&P 500 companies and the profits of all other firms. But it is simply not credible for anyone to believe that the only companies making a profit nowadays are those included in the S&P 500. Many questions over the accuracy of "reported" profits of S&P 500 companies remain unanswered.

For investors, the argument being used by equity analysts and strategists that the equity market is not expensive is based on "reported" and not "actual" profits. The real market multiple based on "actual" profits is considerably higher than what is being sold to investors.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
  • Joseph G. Carson, Former Director of Global Economic Research, Alliance Bernstein.   Joseph G. Carson joined Alliance Bernstein in 2001. He oversaw the Economic Analysis team for Alliance Bernstein Fixed Income and has primary responsibility for the economic and interest-rate analysis of the US. Previously, Carson was chief economist of the Americas for UBS Warburg, where he was primarily responsible for forecasting the US economy and interest rates. From 1996 to 1999, he was chief US economist at Deutsche Bank. While there, Carson was named to the Institutional Investor All-Star Team for Fixed Income and ranked as one of Best Analysts and Economists by The Global Investor Fixed Income Survey. He began his professional career in 1977 as a staff economist for the chief economist’s office in the US Department of Commerce, where he was designated the department’s representative at the Council on Wage and Price Stability during President Carter’s voluntary wage and price guidelines program. In 1979, Carson joined General Motors as an analyst. He held a variety of roles at GM, including chief forecaster for North America and chief analyst in charge of production recommendations for the Truck Group. From 1981 to 1986, Carson served as vice president and senior economist for the Capital Markets Economics Group at Merrill Lynch. In 1986, he joined Chemical Bank; he later became its chief economist. From 1992 to 1996, Carson served as chief economist at Dean Witter, where he sat on the investment-policy and stock-selection committees.   He received his BA and MA from Youngstown State University and did his PhD coursework at George Washington University. Honorary Doctorate Degree, Business Administration Youngstown State University 2016. Location: New York.

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