A debate is intensifying about the role of corporate America in the recent wave of higher inflation. Companies are undoubtedly raising prices. The question is whether they are exploiting a surge in consumer demand or merely passing on their own higher costs. The available data strongly suggests that companies are raising prices to enhance profits.
The view of price increases most generous to U.S. companies is that constrained supply lines and labor shortages are raising the cost of doing business, forcing them to pass on those higher costs to consumers. A more skeptical view is that companies are raising prices because they can. Consumers are spending more, fueled by record amounts of fiscal and monetary stimulus, skyrocketing home prices, excess pandemic savings and pent-up demand from two years of isolation. The combination of higher demand and short supply gives companies an opening to raise prices.
Judging by their own financial statements, companies are seizing that opportunity. Starting from the top of the income statement and working down, the first point of interest is gross profit, which is the difference between a company’s sales and cost of goods. That’s accounting speak for simple math. Say I run a lemonade stand. If I sell a cup of lemonade for $1 and it costs me 70 cents for the cup, lemons, sugar and water, my gross profit is 30 cents. My gross margin, which is the gross profit divided by sales, is 30%.
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If companies are only passing on their own higher costs to consumers, their gross margins should stay roughly the same. But that’s not what’s happening. Gross margins for the S&P 500 Index rose to a record 35% last year from 34% the year before. And that’s just the beginning. This year, Wall Street analysts expect gross margins to shoot up to 45%, based in part on companies’ own projections. In other words, companies appear to be raising prices much higher than their cost of goods.
The next stop on the income statement is EBIT margin, which stands for earnings before interest and taxes. EBIT margin tacks on operating expenses such as wages, rent and utilities — basically everything except interest on debt and taxes. EBIT margins rose even more than gross margins last year to a record 16% from 10% the year before, which, perhaps not coincidentally, approximates the jump in inflation last year. Analysts expect EBIT margins to climb to 17% this year. Here again, higher prices appear to more than offset any increase in companies’ operating costs, including higher wages.
The last stop on the income statement is profit margin. Tax rates haven’t changed in the last year, although interest rates have risen modestly. Even so, profit margins rose to a record 13% last year from 9% the year before, and analysts expect profit margins to reach 14% this year. With margins across the income statement at all-time highs and rising, it looks as if companies are raising prices more by choice than necessity.
Granted, the S&P 500 is unusually top heavy. Apple Inc., Microsoft Corp., Amazon.com Inc. and Google parent Alphabet Inc., quasi monopolies with enormous pricing power in any environment, account for about 20% of the index. But margins are swelling across the board. The numbers are similar for the S&P 500 Equal Weight Index, which, as the name suggests, equally weights the companies. Margin expansion is also roughly the same across the S&P 500’s 11 sectors, the only exception being that analysts expect tighter margins for financial companies this year. Even the Russell 3000 Index, which includes most of the U.S. stock market, tells a similar story. So profiteering seems to be the rule rather than exception.
To be sure, some companies have been forced to raise prices to stay afloat. And in any event, companies are entitled to maximize profits by charging the highest prices the market will bear. But it’s worth thinking about the consequences. It means companies are more than taking back the pay raises they gave employees by increasing prices on goods and services workers need. It also means companies are widening already high wealth and income inequality by suppressing real wages even as they enrich shareholders through higher profits.
It’s hard to pinpoint exactly what’s driving inflation in an economy as sprawling and complex as that of the U.S. But when it comes to whether corporate America is pushing prices higher or just trying to absorb them, companies have already answered the question.