GOLDMAN: Sorry Wall Street, Here's The Truth About What's Going To Happen To Profit Margins

As Henry Blodget pointed out earlier, analysts are wildly optimistic about corporate profit margins right now.

Despite the fact that margins are at record highs, analysts see them going higher!

This chart from James Montier shows what’s up.

Click on the image to enlarge it.


Photo: GMO LLC

So what’s a more realistic outlook for margins?

In a recent note, Goldman’s David Kostin warned that the S&P is still going to fall to 1250 at the end of this year (for context it’s at 1397 right now), and he cited margin compression is one reason why things will go south.

So what’s Kostin’s margin outlook?

This chart contrasts his outlook vs. the consensus. The blue dotted line his his take, and as you can see, it’s not a collapse, but it’s significantly below what the rest of Wall Street currently believes.


Photo: Goldman Sachs

So the question, then, is why is Wall Street so confident that margins will continue to increase, when they’re already at a peak?

Apparently it has a lot to do with the surging margins of the tech industry:

Information Technology is the largest sector in the S&P 500 and currently accounts for
more than 20% of the equity capitalisation of the index. For nearly 30 years the sector’s net
margins generally ranged between 6% and 10%. However, beginning in 2009 margins
began to leap higher and now stand at 16.6% on a trailing four-quarter basis as of 4Q 2011.  

Bottom-up consensus forecasts Tech margins will reach 17.8% in 2012 and 18.6% in 2013.
Our top-down model forecasts the sector’s margins will climb slightly to 16.9% this year
and 17.0% in 2013. One explanation for the surge in Information Technology margin has been the structural shift from hardware and software to internet and cloud-based companies. 

That story — that the shift from low-margin hardware to high-margin services/software — is a compelling one, and there is evidence that the secular shift towards higher margins is real, but…

It turns out that a lot of the margin expansion is attributable to just one company: Apple.

However, the recent increase in the Tech sector margin is entirely attributable to AAPL. During 4Q 2011 the Tech sector posted year/year EPS growth of 18% and margin expanded by 39 bp to 17.7%. Excluding AAPL, the year/year EPS growth was just 1% and sector margins actually dropped by 107 bp to 15.6%.  

Apple is now such a huge player in the market that it basically dictates the index, and so it should be no surprise that so much of the margin discussion revolves back to this one company.

If you think that Apple can keep growing like crazy, and lift the entire boat, then that’s great. But for most of the market, we’re seeing signs of margins already rolling over.

SEE ALSO: Why Goldman says the S&P is going to 1250 >

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.