Dr. Jeff Miller wrote an interesting question the other day:
Why does a Shiller disciple care about profit margins?
Now, I am not a disciple of Dr. Shiller, I disagree with him on many issues, Trills for an example. When Shiller talks, odds are 50-50 that I agree, which makes him interesting to me, unlike Bernanke and Krugman who I almost always disagree with, and James Grant and Caroline Baum, who I almost always agree with. Someone who agrees with me and disagrees with me equally is interesting, because he makes me think harder.
And with his cyclically-adjusted price-earnings [CAPE] ratio, I was a reluctant partial convert. Consider this piece.
There are a couple ways to answer the question:
Most stocks are cheap on a forward P/E basis, less so on a trailing P/E basis, and still less so on a P/B or P/S basis. The difference between P/E and P/S is profit margin - E/S.
Consider the critiques from Dr. John Hussman, who awaits the reset that will come if/when profit margins get competed down.
My answer: we should care about it a little, for the above reasons. But labor is no longer scarce, which leads to higher profit margins for a time while wages are depressed.
My view is that profit margins will not revert to mean for many years, until the increase in capitalist labor is absorbed. Until then economic results will be poor for those that labor on the low end - you have got a lot of new competition.
A reason to consider the validity of the CAPE is twofold: It has a huge similarity to Tobin's Q-ratio, which compares market capitalization to replacement cost. It also has a similarity to Michael Alexander's Price-to-Resources ratio, out of which the book makes a lot (link here for an example). It's a Price-to-Adjusted Book value ratio as I see it.
The CAPE has value as a proxy. It mirrors overall market value pretty well, like other fundamental ratios.
But I don't agree, at least in part because profit margins should remain high, until readily obtainable labor is less scarce. Getting there could be a long time. Profit margins could remain high for a long time as a result, leaving markets in a limbo zone, where it treads water as underlying value builds.
So profit margins should remain high for now. Once labor is scarce globally, and companies must pay more to get more or better quality labor, then will profit margins come under stress.