What Oil Does to Profit Margins

Paradoxically, or at least counterintuitively, it turns out that falling oil prices are a net negative for corporate profit margins. This despite the fact that energy is an input cost for making and moving stuff around in the economy. A rational person would guess that a lower energy cost is an overall positive for corporate profit margins, but it actually doesn’t end up working that way.

In stock market terms, the benefits of a lower oil / gas prices do not boost profit margins enough to offset the drag on margins coming from the energy sector, which is something like 8% of the S&P 500’s market cap weighing right now (down from 12%).

Here’s Liz Ann Sonders, Chief Strategist at Charles Schwab, on the right way to think about corporate profit margins – which, net of energy companies, are still sitting at all-time record highs:

Profit margins under pressure

From an all-time high of over 9% reach in 2014, S&P 500 profit margins have dropped by 60 basis points over the past year and now sit at 8.5%. Declines of this magnitude are rare outside of recessions, other than in 1985, which was the only time in the past 40 years margins dropped this much without an attendant recession according to Barclays. It’s an important reference point because profit margins fell in 1985 due to a 60% plunge in oil prices; while profit margins outside of the energy sector remained stable.

Over the two years, energy sector net profit margins have imploded from over 8% and are now on their way toward 2%. On the other hand, the collective revenue-weighted net profit margin of the other nine S&P sectors has continued to trend marginally higher and sits near an all-time high, which means earnings pressure will also be mostly felt within the energy sector.

More from Liz Ann on the possibilities of an earnings recession in her latest commentary below:

Under Pressure: Earnings Recession Warning; Economic Recession Watch (Charles Schwab)

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