Fat Profit Margins Continue To Be The Big Driver Earnings Growth

Fattening profit margins have enable corporate America to generate impressive earnings growth despite lackluster sales growth.

Among other things, corporations have been able to do this because they have been able to squeeze more productivity out of fewer workers without having to raise pay by too much.

However, this model for growing profits obviously has limits. And some warn that a mean reversion in record-high profit margins will come soon.

But according to the early read on Q1 earnings announcements widening profit margins continues to be the key source of earnings growth.

Here’s JP Morgan Funds’ Joseph Tanious and Anthony Wile based on earnings announcements through April 28:

It is also worth mentioning that stronger-than-expected profit margins have helped drive results this quarter. Chart E breaks down the growth in this quarter’s EPS by sales, margins and the index divisor* which includes share buybacks and constituent changes. While all three components have contributed in varying amounts to earnings growth since the recession, this quarter’s equal split between revenue and margin growth is a welcome signal, as companies will likely find it harder to rely on cost cutting in order to drive future earnings growth.

Margin strength is only a slightly bigger contributor to earnings growth than is sales growth. But it’s clearly not a detriment.

For now, the profit margin bears will remain at bay.

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