Back in February of this year, I wrote an article about why I felt Corporate Profit margins were likely to fall in the coming years ahead. That article can be found here.

There were two main reasons for why I believed this to be so:

Record high corporate profits as a percentage of GDP Record low corporate taxes being paid as a percentage of pre-tax corporate profits

The premise was and still is, that in a free market, the invisible hand of competition has a way of correcting imbalances and keeping order in the business world. Fierce competition for high profits should in itself bring profit margins down back to at least average historical rates.

Granted, these days, the market isn’t so free. Central Bankers of the world have a heavy influence on the markets these days from setting interest rates to facilitating bailouts for one another’s country or country’s banks.

Also, as I pointed out in my previous article, wages as a percentage of GDP are also at historical low levels, implying that the structure of our GDP has changed over these last 60+ years. Perhaps this is the “new normal” structure of our GDP where a greater percentage goes to corporate profits and a lesser percentage goes to the working class through wages.

In the meantime, let’s do a follow-up on what has been happening to corporate profits as a percentage of GPD and corporate taxes paid for 2010 as a percentage of pre-tax corporate profits.

Here is a chart of corporate profits after tax up to 2011 Q2.

In Q2 2010, after tax corporate profits were $1465.9 Billion and in Q2 2011, they were $1466.5 Billion. There was only a very slight increase year over year.

Let’s now look at what the GDP has done recently and then what the percentage of profits was to GDP.

Here is a chart of GDP over the last 2 years.

GDP has been climbing steady up to the Second Quarter of 2011 when it reached $14996.8 Billion, up from $14467.8 Billion in the Second Quarter of 2010.

Here is the chart I created last February of corporate profits as a percentage of GDP up to Q3 2010 when corporate profits reached 9.61% of GDP.

The historical average since 1947 has been 6.05%.

Let’s take a look at the last 5 quarters profits as a percent of GDP:

Note: These are after tax corporate profits

Source: St. Louis Fed

Q2 2010 GDP $14467.8 Corp Profits $1465.9 = 10.1%

Q3 2010 GDP $14605.5 Corp Profits $1414.2 = 9.7%

Q4 2010 GDP $14755.0 Corp Profits $1337.8 = 9.0%

Q1 2011 GDP $14867.8 Corp Profits $1454.8 = 9.8%

Q2 2011 GDP $14996.8 Corp Profits $1466.5 = 9.8%

One observation we can make from this data is that the year over year figures comparing Q2 2010 to Q2 2011 is down from 10.1% to 9.8%.

Given that the historical average since 1947 is 6.05%, I expect to see more year over year declines in corporate profits as a percentage of GDP.

Now let’s look at corporate taxes and compare the percentage of taxes to total pre-tax corporate profits. The last time I looked at this, corporate taxes as a percent of pretax profits were at record low levels.

Here is the chart I created back in February, annually, corporate profit taxes as a percent of pre-tax profit:

This chart above goes out to 2009 and I posed the question, “How much lower can corporate taxes go.”

Here is a chart of Federal Taxes on Corporate Income:

In 2009, only $201.7 Billion was paid in corporate income tax. In 2010, it was $329.6 Billion, a large increase.

Total Corporate Profit after tax in 2010 was $1408.4 Billion, a record year! Adding the $329.6 Billion paid in Federal Income taxes gives us a pre-tax profits of $1738.0 Billion.

The percent of Federal profit tax of the corporate pre-tax profits for 2010 was 19%, which is historically very low.

Paying lower incomes taxes is a good reason for why corporate profits as a percent of GDP are also so high historically.

The only invisible hand at work with respect to the taxes corporations pay is Washington. My bias is that this sub 20% corporate profit tax rate is on the low end and will probably be rising in the years ahead to combat our country’s deficits.

In conclusion, corporate profits remain frothy relative to percent of GDP. According to the Yahoo Analysts Estimate page for any stock, earnings for the S&P 500 are estimated to grow 10.77% annually for the next 5 years (see note below). I believe that is simply too optimistic and that the market is likely to be disappointed on the earnings front in the years ahead. I remain bearish on US equities in the aggregate.

Note: To confirm the S&P earnings estimate, see the rightmost column in the bottom table of any Yahoo Finance stock earnings page (e.g., Microsoft).

(c) Tillberg Capital Management, Inc.

Tillberg Capital Management, Inc.

Via Advisor Perspectives

Images: Flickr (licence attribution/Thomas Hawk)

About The Author

My original dshort.com website was launched in February 2005 using a domain name based on my real name, Doug Short. I’m a formerly retired first wave boomer with a Ph.D. in English from Duke. Now my website has been acquired byAdvisor Perspectives, where I have been appointed the Vice President of Research.

My first career was a faculty position at North Carolina State University, where I achieved the rank of Full Professor in 1983. During the early ’80s I got hooked on academic uses of microcomputers for research and instruction. In 1983, I co-directed the Sixth International Conference on Computers and the Humanities. An IBM executive who attended the conference made me a job offer I couldn’t refuse.

Thus began my new career as a Higher Education Consultant for IBM — an ambassador for Information Technology to major universities around the country. After 12 years with Big Blue, I grew tired of the constant travel and left for a series of IT management positions in the Research Triangle area of North Carolina. I concluded my IT career managing the group responsible for email and research databases at GlaxoSmithKline until my retirement in 2006.

Contrary to what many visitors assume based on my last name, I’m not a bearish short seller. It’s true that some of my content has been a bit pessimistic in recent years. But I believe this is a result of economic realities and not a personal bias. For the record, my efforts to educate others about bear markets date from November 2007, as this Motley Fool article attests.