By Rebecca Ellis
THUR, MAY. 04 2023-theGBJournal| With the U.S. quarterly earnings season in full swing, stellar numbers already reported by Procter & Gamble, Microsoft and Alphabet could entice equity investors currently on the sidelines.
Even so, the collapse of First Republic Bank – whose assets will largely be absorbed by JPMorgan – will keep the markets circumspect as recessionary fears remain to the forefront.
Returning to the strong performance of consumer giant P&G, along with drinks behemoths Coca-Cola and Pepsi, a read-through of the numbers shows that solid revenue increases have been largely driven by price hikes on the back of soaring inflation. At least in Procter’s case, the effect of increased prices more than offset a dip in sales volumes, meaning that input price increases were passed on to the consumer with an extra margin added on.
One banking analyst has referred to these as “greed profits” – where companies force through price increases to reflect rising inflation, but resist reining them in when inflation retrenches. The question is whether this is sustainable in the longer term, and what effect it might have on the overall economy.
Absent comparable wage rises, increasing consumer goods prices will lead to a reduction in overall disposable income, which will in turn impact sales volumes of discretionary items. As a result of reduced purchasing power consumers may put off large ticket discretionary spending such as replacing their car for another year. That will in turn reduce the profits of car manufacturers, already impacted by increased input prices, or force them to cut costs to boost sales, meaning they either need to improve production efficiency or reduce labour costs to preserve margins. The latter measure will, of course, further reduce the disposable income of the car manufacturers’ workforce…
On the other side of the equation, there has been widespread talk – albeit little action as yet – of governments imposing a one-off tax on the excess profits of perceived price-gougers. If we consider this a serious possibility, then we need to evaluate the regulatory risk of holding the stocks of companies engaged in such practices, a risk that could ultimately be reflected in their share prices.
There is a non-negligible possibility that investors who feel strongly about such issues as price gouging and/or those who want to limit their exposure to regulatory risk might decide to tilt their portfolios in favour of companies with fewer perceived ethical and/or regulatory issues.
While eye-watering profits may indeed be a sign of corporate greed, they may also indicate a structural lack of competition in certain sectors which allows companies to get away with heavy price hikes. But, at least according to the theory that markets are efficient, sustained excess profits will both attract competition and/or suppress consumer demand, even in the case of products where demand is fairly inelastic.
Therefore, consumer goods companies currently enjoying fat profit margins could face a double whammy if such margins prove attractive to competitors while at the same time consumers with reduced purchasing power trim their spending. Moreover, investors with ethical qualms may choose to dump their shares and consumers may boycott their products. Over past decades, public and shareholder indignation towards companies including BP, Nestle, GlaxoSmithKline and Nike have forced these companies to introduce changes on their business practises.
Legendary investor Warren Buffet – a long-time investor in Coca-Cola – is known for his laser sharp focus on competent management, steadily improving profitability and dividends that increase over time. What is less knows is that management integrity and clear governance are also important pillars of his value-investing philosophy.
With companies such as BP on shaky moral ground and seen as at least partly responsible for the at least four energy price jumps that have shackled UK consumers, companies in sectors that have seen more moderate price increases may hold more value for investors.
Rebecca Ellis is Family office advisor| Co-author Martin de Sa Pinto, Martin de Sa Pinto Research| Contact:
re@aktspartners.ch
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