After a Bumper 2021, Companies Might Struggle to Increase Profits

A New York Times analysis of over 2,000 publicly traded companies outside the financial sector found that most of them increased sales faster than expenses, a remarkable feat when the cost of wages, raw materials and components was rising and supply chains were out of whack.

As a result, profit margins, which measure how much money a business makes on each dollar of sales, rose well above the prepandemic average. On the whole, companies made an estimated $200 billion in additional operating profits last year because of that increase in margins.

The windfall sent stocks surging in a wave of market exuberance but potentially beyond what business fundamentals merited. The price-to-earnings ratio — an indicator of how much investors are paying for each dollar of corporate profit — for all of the companies in the S&P 500 climbed to 23 at its peak, compared with an average of 18 for the decade before the pandemic. At such an elevated price-to-earnings ratio, stock prices were particularly vulnerable to a sell-off.

And now there are good reasons for investors to be concerned about profits. Many federal stimulus programs created during the pandemic have ended or are ending. The Fed is raising interest rates. And corporate executives are warning that the supply chain problems that may have helped them boost profits last year have become a burden.

Deere, the maker of agricultural, construction, gardening and other equipment, said that materials costs were still rising, and that it lacked parts to complete certain products, delaying sales. Cisco, which makes computer networking equipment, also complained that it couldn’t get certain components.

Particularly worrisome to investors are signs that demand for some goods and services is flattening or even falling. Walmart noted that higher food costs appeared to have reduced demand for other items. And while Target expected demand for things like apparel and home goods to fall as the government stimulus wore off, the company “didn’t anticipate the magnitude of that shift,” its chief executive, Brian Cornell, said.

Shares for the clothing retailer Gap fell sharply last week after it announced disappointing earnings for the first three months of the year, as well as a more pessimistic outlook for its profits through the rest of 2022. The firm was greatly affected by a deep decline in sales for its Old Navy brand, which tends to appeal to lower-income consumers because it carries lower-priced merchandise than Gap stores.