Even as inflation bites, corporate profits remain flush

What’s immune to high inflation? So far, the profits at big U.S. companies.

Businesses are facing higher gasoline and heating bills, just like consumers, in addition to higher expenses for labor and raw materials. But unlike many middle- and lower-income Americans, they’ve been making more than enough extra income to cover the additional costs.

Big companies have successfully raised prices for their products, from cups of coffee to auto parts to cans of paint, because their customers have kept lining up regardless. The result: record profits at the end of 2021 as revenue rose and a good chunk of each $1 of that revenue made it to the bottom line.

“A lot of the price pressures are just getting passed along” from companies to their customers, said Alex Arnon, associate director of policy analysis at the Penn Wharton Budget Model, a research initiative.

What's uncertain is how much longer the trend may last, before customers sharply cut back on their purchases. A U.S. government report on Thursday will show how much buying consumers did in February after taking higher prices into account. In April, more clues will arrive as companies line up to tell Wall Street how much profit they made during the first three months of 2022.

The last such round of conference calls for CEOs was a rousing success for the companies. With customers itching to spend, and many sitting on savings built up with help from U.S. government stimulus programs, CEOs often pointed to “low elasticities of demand." That’s an economist’s way of saying customers continued to buy even when prices were rising, and it means companies have less incentive to keep prices low.

“The overwhelming message from most companies in this earnings season is still that demand remains strong and continues to exceed their ability to meet it,” Deutsche Bank Chief Strategist Binky Chadha wrote in a recent report about the fourth-quarter results.

The coffee giant Starbucks raised prices once in October and then again in January, for example. Executives recently told Wall Street it was planning more increases to help “mitigate cost pressures.”

Those past price bumps didn't discourage Starbucks customers, John Culver, group president, North America and chief operating officer, told analysts during a call last month. “To the contrary, our customer demand continues to grow.”

He made the comments after Starbucks reported a 31% jump in profit for the latest quarter from the prior year. Wall Street expected even stronger growth.

Companies aren’t able to blindly raise prices across the board. At Amphenol, which sells fiber optic connectors, antennas and other products to manufacturers, CEO Adam Norwitt said prices are easier to raise in some markets than others.

“We were there for our customers through the pandemic,” he said in a call with analysts. “We were there for them when maybe others were not through the supply-chain crisis. And so that, all things being equal, should position us well to be able to ask nicely of our customers that they should share in that.”

Amphenol reported record earnings per share and record revenue for the last three months of 2021.

Earnings across S&P 500 companies jumped a little more than 30% in the latest quarter. Margins, which show how much profit companies make off every $1 in revenue, remained near record levels, even as expenses sometimes rose by hundreds of millions of dollars.

In the last three months of 2021, companies in the S&P 500 held onto $12.40 of every $100 in revenue as profit, according to FactSet. That’s down a bit from previous quarters, but still above the average of $11 over the last five years.

For the first three months of 2022, analysts expect a further dip to $12.20, partly because costs continue to rise.

The story for many U.S. households has been more painful, with the least wealthy Americans hit hardest by the price increases coming from companies. Even though many workers got raises last year, they often weren't enough to cover higher bills.

The typical working household making $40,000 to $60,000 earned $2,193 more in 2021 than the year before, according to an analysis by Penn Wharton Budget Model. That fell short of the $2,712 in additional costs due to inflation, leaving that household $519 in the hole.

And the pressure may crank even higher after Russia's invasion of Ukraine, which caused extreme price swings for oil, wheat and other commodities the region produces.

“The consumer has been able to accept higher prices, so far,” said Nate Thooft, chief investment officer of multi-asset solutions at Manulife Investment Management. “I say so far because the game is being ramped up again with gas prices at all-time highs.”

The war's exact effect on inflation is unclear. Oil prices have been nearly as quick to plunge as to surge recently, for example, given all the uncertainties.

Economists aren’t surprised corporate profit margins have remained so high, which they say is a result of the economy roaring out of its coronavirus-caused shutdown. Buyers are increasing their purchases faster than businesses can increase the amount of stuff on shelves to sell.

“There’s so much capital out there, it’s so easy to get and almost free” with interest rates near record lows, said Ann Miletti, head of active equity at Allspring Global Investments. “It’s not surprising that growth rates have stayed higher, margins have been more sustainable and consumers have had more in their pockets to spend.”

Now the Federal Reserve has begun raising interest rates off record lows, which should slow purchases. U.S. households may also be set to return to more “normal” buying activity, no longer fueled by as much government stimulus. They may also exhaust the pent-up demand from the pandemic.

The hope among economists is that capitalism will also do what it does, and the high profit margins signal to companies they should ramp up production to maximize their sales. New competitors should also be attracted after seeing the big profits available. All that should lead to slowdowns in price increases and a steady erosion of margins.

That’s the optimistic scenario in the eyes of Arnon at the Penn Wharton Budget Model. But he acknowledges worse-case scenarios that could lead corporate profit margins and inflation to stay high. They chiefly center around an economy that's no longer well-functioning or competitive.

“If two years from now, we’re talking about margins going up from here,” he said, “that would be the clearest signal.”