Despite the sluggish U.S. economy (high unemployment, depressed housing, strained government and individual finances), many large U.S. Corporations remain highly profitable. Over the past five years, large American companies, as represented by the S&P 500, have outperformed MSCI EAFE (European, Australasian, Far Eastern), and FTSE China 25 (Chinese) companies. (see chart below - click to enlarge)
SPDR S&P 500 (SPY)
iShares MSCI EAFE Index (EFA)
iShares FTSE China 25 Index Fund (FXI)
According to data compiled by Bloomberg, S&P 500 profits doubled since 2009. The market has followed suit with the index jumping about two times since its 2009 lows. Even with such large gains, the index's so-called earnings yield is close to the highest on record when compared with the 10-year Treasury rate (albeit the 10-year Treasury has been falling). How is this possible, and can this continue? According to economist and business reports, the resiliency in corporate profits can be explained by three market forces: globalization, technology and supply chain efficiency.
Globalization - U.S. companies have discovered the advantages of outsourcing low value-added production and service operations to countries with an abundance of productive and low-wage laborers. Assembly plants in China and call centers in India are two examples. Outsourcing enables companies to retain the more skilled and higher value-added distribution, design and technical production processes in their home countries while importing services and goods with lower valued-added components. By doing so, they are optimizing their production cycles and minimizing their costs, thereby improving margins.
Technology - The technological innovation of business-to-business e-commerce has changed the cost and profit picture for many U.S. companies. In 2003, approximately 21 percent of U.S. manufacturing sales and 14.6 percent of wholesale sales were e-commerce-related. By 2010, those percentages had increased to 46.4 percent for manufacturing and 24.6 percent for wholesale trade.
Supply Chain - Supply chain efficiency has allowed U.S. companies to maintain lower inventories and avoid overshooting (accumulating excess inventory) when a slowdown occurs. This helps corporate profits to snap back more quickly. Inventory-to-sales ratios adjusted for inflation have been trending down for the retail and wholesale trade over the past 15 years.
The U.S. Department of Commerce reported that U.S. corporate profits (which include both domestic and foreign profits) now make up the largest percentage of the country's gross domestic product [GDP] since the 1950s. This ratio currently stands at just under 13 percent of GDP, amounting to a total of $1.9 trillion USD.
Conversely, wage and salaries have been slowly trending downward from 47 percent of GDP in 1985 to 44.4 percent more recently. These trends seem to point to increased inequality between workers and owners, driven to some extent by the outsourcing of lower-skilled jobs to emerging countries (largely, Asia).
Below are five large American businesses (including profitability profile) that stand to benefit from the market forces of globalization, technology and supply chain efficiencies in the foreseeable future:
Source: Seeking Alpha
Apple, Inc. (AAPL)
Amazon.com, Inc. (AMZN)
Costco Wholesale Corporation (COST)
NIKE, Inc. (NKE)
Wal-Mart Stores, Inc. (WMT)
Because Apple's profit and growth picture is the best among the five companies, Mr. Market has rewarded Apple's stock accordingly (see chart below - click to enlarge).
Investors might consider buying one or all five American companies listed above provided that globalization, technology, and supply chain efficiency continues to advance in a global economy that is not in recession. Another option worth considering is to buy an index fund such as the S&P 500 (a free-float capitalization-weighted index based on the common stock prices of 500 American companies).
Disclosure: I. Hold a partially covered call position in SPY.
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