Mighty Dodge Ram said:
Unfortunately, a 300% increase in profit during tough inflationary times for consumers is the dark side of capitalism.
A 300% increase in profit can only mean one thing.............or does it?
I'm in the odd (OK, strange) position of having earned a degree in geology, with a minor in economics, way back in 1978. After just 6 years on the road on mineral exploration projects, I decided having a home life with my wife and our infant son was more important than the joys of bombing around in trucks breaking rocks for a living. Returned to my hometown of Raleigh, NC, went back to college, and two years later emerged with a CPA certificate. All of that is to say that the inner workings of accounting and tax law have been my focus for 38 years now.
It's impossible to draw many, no, any conclusions with a single fact such as a 300% increase in profit. Over what time frame? A 1% of gross revenue profit grows to a 3% of gross profit? A $10 profit in a year's time grows to a $30 profit? Context means everything when it comes to financial statement analysis.
I like to tell a little story about Company A and Company B, then ask what the listener's (reader's) think about the companies involved. These are real-world large publicly traded multinational corporations based in the US. While they're in wildly different industries, each is a vertically integrated enterprise which produces a product line formed by their efforts and processes from raw materials to retail sales. As publicly traded corporations based in the US, there are no shenanigans as to how gross revenue, costs of goods sold, overhead expense, and net income (profit) are computed. All large US corporations are required to play by the same rules as to how income, direct costs, and overhead are computed, and all must submit to annual financial statement audits by independent CPA firms in order to demonstrate that they're doing exactly that.
So, from the beginning of 2013 through the end of 2021, Company A saw gross revenue increase in 8 of the 9 years, with the one year of revenue decline of about 9% from the prior year's gross. By year 9, 2021, the gross had more than doubled from year 1. And Company A was producing strong profits, expressed as a percentage of gross revenue, in each of the 9 years. The lowest level of profit was 20.9% of gross while the highest profit rate was 25.9%, with a 9 year simple average of 22.4%.
From 2013 through 2021, Company B saw gross revenues swing through a broad range of values, with the lowest revenue years coming in at less than 50% of the highest year's gross. In 5 of the 9 years Company B's gross was greater than Company A's. Company B's profits, expressed as a percentage of gross revenue, varied widely, with highest annual profit being 8.1% and one year showing a 12.4% loss. Their 9 year simple average was 4.7% of gross revenue. The difference between the highest profit year and the loss year was around 250%.
The dollar volume of profits earned by Company A, with its much greater degree of profitability, ranged from a low of $41.7B (billion) to a high of $94.7B. There were no loss years, and the smallest annual profit was in 2014 when it earned $39.5B. Company B, with its widely varying gross revenue and a profitability of around 20% of Company A's, earned a high of $23.1B in one year and had a low of a $22.4B loss in their worst year of the 9.
Company A's profit nearly doubled in terms of dollars of profit from 2020 to 2021, leaping from $57.4B to $95.7B. Company B also saw an extraordinary leap in profit from 2020 to 2021, coming out of the $22.4B loss in 2020 to post a $23.0B profit in 2021. So it can be observed that both Company A and Company B rebounded from a less than stellar 2020 to a strong recovery in 2021. It should be observed that Company A still earned a 20.9% annual profit in 2020 and managed to make the aforementioned $57.4B, while Company B suffered a huge loss in 2020 and in some ways was fortunate to survive.
Company A manufactures a product line holding a material portion of the global market for similar products. It has an absolute monopoly on its proprietary goods and intellectual property. The great majority of Company A's manufacturing processes take place outside of the US, primarily in China. A large portion of the raw materials used in the production of components for Company A''s products come from outside of the US also, primarily from China. Company A alone sets the price of its products at the retail level--there is no competition--if you want a product to do exactly what Company A's do, you're buying from Company A or you're doing without.
Company B produces products which are, from the raw material starting point all the way through to the finished retail product, a fungible commodity. Fungible commodity is a fancy economic term for goods or materials available widely, without meaningful distinction among suppliers, and without meaningful differences in suitability for the purposes of the buyer. Fungible commodities also share the characteristic of being bought and sold on markets all over the globe with supply and demand setting the prices, not the producers themselves. Corn and wheat are good examples of fungible commodities. The production of Company B's products require enormous investments in capital infrastructure and there are risks of catastrophic financial loss at essentially every step of the way from the beginning of the process to the retail purchaser. Many years, and in many cases, decades, pass between the starting point of the process until revenue begins to be received, and more years often pass before profits are realized.
Surely by now everybody knows where this is going--only the exact names may still be a mystery. Company A is Apple, Inc. Company B is Exxon-Mobil. The gross revenue figures and net income (profit) figures took me about 120 seconds to pull up courtesy of Google. Yes, Exxon-Mobil saw extraordinary increases in profit, expressed as a percentage of gross revenue and in hard dollars, from 2020 to 2021. So did Apple. Exxon-Mobil clearly needs (at least clearly to this old geologist-turned CPA) a highly profitable year now and then in order to offset the low profit and loss years. It's not so clear that Apple needs 9 successive highly profitable years. Maybe just because they can?
Now just a few words about Exxon-Mobil's "obscene profits" or "windfall profits": Exxon-Mobil and most producers of oil and gas faced investor revolts in the mid- to late 20-teens. Shareholders were tired of modest dividend yields and absence of strong share value growth curves. They demanded curtailment in exploration and production expenditures with higher dividend payouts and stock buybacks as uses of the cashflows, not reinvestment in increased production. Then, in 2020, political pressure began to mount with the stated goal said in so many words to be the outright destruction of their industry. The pressure increased in 2021 with every level of executive power focused on immediate curtailment of increases in production, from cancellation of lease sales to regulatory obstruction at every stop along the way from well to pump. The Treasury Department openly chastised the capital markets for providing debt and equity capital to the industry and spoke sternly of regulatory interference to prevent capital from reaching the industry. With all of that, small wonder that exploration and production expenditures ground to a quick halt, while in the accounting sense, no wonder that with the market forces driving prices and gross revenues up, the cutbacks in exploration and development expenses dropped straight to the bottom line. Ain't nowhere else for it to go!
So, after some careful reading, some independent study, and some individual experiences with Apple and with Exxon-Mobil, or their ilk, which Company do you think is the profiteering price gouger? Please show your work to your classmates, which include all of us.
Thanks for reading. Looking forward to hearing more from this august group.
Foy
