Over the course of the past several years, I've noticed an increasing number of people referencing "Operating Earnings" as a proxy for S&P 500 (SPY) profitability, often without any regard for either the definition or implications of this measure. The problem is that S&P's Operating Earnings are overly optimistic and arguably misleading.

Firstly to clear up any possible confusion, the term "operating earnings" (along with operating income and operating profit) is commonly used interchangeably with EBIT (earnings before interest and taxes). By factoring out the effects of capital structure (interest) and the sometimes volatile tax components (both of which are unrelated to day-to-day operations), EBIT is designed to give an idea of how a company performed operationally. This makes it a useful tool for examining the prospects for continuing profitability. But this is not what S&P is referring to when it uses the term "Operating Earnings."

Instead, S&P uses

In Part I we took a look at Canadian Oil Sands Ltd. (COS.TO, COSWF.OB) and determined that they have strong historical EPS growth and cash-flow generation, and a dividend that should be sustainable (assuming a relatively stable economic outlook). On the other hand, they do have a high amount of impending Capital Expenditures over the next 2-3 years which will likely have to be partially funded with debt if they wish to maintain their dividend. The good news is that COS can comfortably support a moderate increase in debt. In the second half of this article, we'll take a look at COS's valuation on both a relative and absolute basis.

Normalized Earnings

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Looking at normalized earnings and the associated P/E provides a more comprehensive picture as to how a company's earnings respond to the vicissitudes of the business cycle. On a 5-year normalized basis, COS appears

Introduction and Overview

Canadian Oil Sands Ltd. (COS.TO, COSWF.OB) owns a 36.74% stake in the Syncrude Joint Venture, making them the largest partner involved in the project. This is also their sole producing asset.

The Syncrude operation involves the mining, extraction, and upgrading of bitumen into a light, sweet synthetic crude oil, which fetches a price roughly analogous to WTI crude. Net to Canadian Oil Sands, proved and probable reserves total 1.8 billion barrels, which is sufficient to last around 45 years at current production levels of ~40 million barrels per year.

Over the course of the next several years, until Q2 2015, COS will incur in a large amount of CapEx, totaling roughly 3 billion (a substantial amount when considered in relation to COS's asset base of 10 billion). 2 billion of this total will be devoted to mine train replacements and relocations, which will serve to enhance efficiency

<< Return to Part II

In my opinion, the biggest threat to margins (and by extension, earnings) is revenue sustainability and growth potential, which faces threats on both the domestic and international fronts.

Before I get into that, let me take a second to highlight a risk which I believe is generally overlooked. Given that corporations are running so lean right now (with minimal payroll and expenses), they are more vulnerable to a dip in revenues. Normally corporations use recessions as an opportunity to trim some proverbial organizational fat: they cut non-productive and/or marginally profitable operations, they remove excess labour costs, eliminate redundancies, curtail spending, and plan/position themselves strategically for the ensuing recovery. These actions soften the blow to earnings during recessions. However, over the past several years corporations behaved quite conservatively towards expansion, meaning that they have not had a chance to reacquire very much of these expenses. As

In Part I of this article, we took a look at how margins have behaved over the past decade and determined that the recent rise in margins was the result of corporations slashing expenses rather than growing revenue. Moving on, we'll examine how exactly they were able to do so without causing their revenues to suffer.

There are several possible explanations:

1. Interest rates. With the Fed holding rates near zero for the past 4 years, and for the foreseeable future, it stands to reason that corporate interest payments would have dropped. Despite this, I don't believe that interest rates are a direct contributor to high profit margins for the simple reason that the most burdensome debt is long-term in nature and the rates on these debt issues have been locked in since issuance. Payments on short-term debt, which is rolled over more frequently have likely fallen, but this type

It's no secret that profit margins and indeed corporate profits as a whole have risen to record levels as the economy emerged from the depths of the financial crisis. This has led to a fair degree of skepticism regarding how such a situation transpired given the fragile nature of the recovery, and an even greater degree of debate over the future direction of earnings and margins. How have margins arrived at where they are today, and what specifically led them here? Can the current trend be expected to persist? What are the implications for earnings moving forward? Over the course of this article, I'll use some data on the S&P 500 (SPY) as proxy for answering some of these questions.

To start, how does a company go about increasing its profit margins in the first place, technically speaking? In the most basic sense, there are two different avenues:

1. They can