Big companies are doing something that would be 'impossible' if profit margins were under pressure

We're in the midst of earnings season, a period of time during which companies everywhere reveal tons of information about their industries and the environments in which they operate.

This season, investors and analysts will be laser-focused on any information regarding impacts from the strong dollar, gains and losses from tumbling energy prices, and demand fluctuations caused by the slowdowns in the US and China.

One item that hasn't gotten much attention lately is corporate profit margins, which are near record highs. Ever since the financial crisis, companies have been cutting operating costs, trimming debt, and increasing exposure overseas; all actions which have boosted margins. But as the bull market and economic recovery has aged, we've heard more and more that margins are either topping out, likely to revert to some long-term average, or just collapse.

Morgan Stanley's Adam Parker doesn't see any of tumbling margins quite yet.

"For several years now, there has been an increasingly vocal group of investors and academics arguing that US corporate profitability and productivity has peaked," Parker wrote in a research note on Monday. "We disagree and would point to this quarter's EPS results as yet another counter-example to what we argue is an over-reliance on irrelevant historical comparisons."

Parker notes that while profit growth has been exceeding expectations during this earnings season, revenue growth has not. Generally speaking, when earnings growth is outpacing revenue growth, profit margins are actually expanding.

Here's FactSet's John Butters on Friday with some more color:

Overall, 201 companies in the S&P 500 have reported earnings and revenues to date for the first quarter. On the earnings side, 73% of the companies have reported actual EPS above the mean EPS estimate and 27% of the companies have reported actual EPS below the mean EPS estimate ... However, on the revenue side, 47% of the companies have reported actual sales above the mean sales estimate and 53% of companies have reported actual sales below the mean sales estimate ... Due in part to more companies missing sales estimates than beating sales estimates, the blended sales decline is larger today (-3.5%) compared to the start of the quarter (-2.6%). On the other hand, due in part to more companies beating EPS estimates than missing EPS estimates, the blended earnings decline is smaller today (-2.8%) compared to the start of the quarter (-4.6%).

"That is an impossible combination of data if margins were under pressure!" Parker exclaimed. "While the absolute earnings upside largely reflects the "beat and guide lower" that occurred last quarter, the revenue weakness coupled with the large earnings beat relative to consensus is the key to assessing margins."

So based on Parker's assessment, it looks like the profit margin debate will drag on a little while longer.

FactSet