Profit margin have expanded, thanks to four key trends:
- Strong commodities prices
- Emerging market cost arbitrage (companies making things more cheaply in emerging markets)
- Demand growth from emerging markets
- Improved corporate efficiency driven by the use of new technology
- (+) the market has rewarded companies that have undertaken mergers and share buybacks, as opposed to companies that have invested internally, further bolstering margins
In other words, profit margins should naturally mean-revert and oscillate. The existence of fat margins should encourage new competitors and pricing cycles that cause those margins to erode; conversely, at the bottom of the cycle, low margins should lead to weaker players exiting the business and giving stronger companies more breathing space. If that cycle doesn’t continue, something strange is taking place.