Sunday Spectacle XCXI




(charts from "Go Big, The Investment Case for Multinationals," Robert Hagstrom. LMCM, Nov 2010)


Shouldn't be surprising to see that larger companies in the S&P 500 earn more overseas. The difference is very pronounced for S&P 100, which is a subset of S&P 500 and contains the largest companies in America. Around 68% of the companies in the S&P 100 earn 25%+ of their revenue overseas.

The bottom chart, showing the local vs foreign profit margin, shows how profit margins have collapsed in America in the last few years. You can read this two ways. The first way is to follow the suggestion of the author of the document containing these charts and favour companies earning foreign income. The profit margins have remained high overseas so a bullish outlook will try to capitalize on that.

The alternate view is to remain contrarian. Not only are the foreign profit margins higher than the local (US) one, they have also been higher in the last decade than in the 90's. Unless you have a good reason to justify why foreign profit margins should be higher now than in the past, you should remain cautious. In my view it is far more likely for the profit margins to mean-revert to what they were in the late 90's. In fact, it does seem like the foreign profit margins peaked in 2006 and have been trending down somewhat. My guess is that the higher profit margins are from the commodity complex but I can't say for sure without analyzing the data. Needless to say, it is very easy to cook up scenarios for commodity prices to revert to what they were ten years ago (in real terms).

I also wonder if the market is concerned with the latter point I made above. I haven't been following markets for very long but one striking thing is how the market is pricing megacaps at low P/E multiples. The best-of-the-best are priced at lower multiples than smallcaps or midcaps. I wonder if the market is doing this because a lot of the profits for the larger companies come from overseas business, and as you see in the chart above, the overseas profit margin looks abnormally high compared to recent history. I wonder if the market is pricing in the possibility of profit margin contraction in overseas markets?

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