Over the past few years, investors have been confronted with lockdowns, the threat of economic collapse, surging inflation, war and rising interest rates. Now, they face a new challenge: A pushback against corporate profits.
Banks, energy producers and grocery chains, in particular, are being battered by top political voices who have cast aspersions on profits and drawn connections between corporate success and inflation.
Investing in any of these sectors, it seems, has become morally questionable – and potentially risky. But there are several reasons why investors should tune out the political noise and stay the course.
Admittedly, the opponents have a big megaphone. U.S. President Joe Biden renewed his attacks on energy producers this week.
In a tweet, Mr. Biden warned the oil industry that it faces a stark choice: “Either invest in America by lowering prices for consumers at the pump and increasing production and refining capacity. Or pay a higher tax on your excessive profits and face other restrictions.”
Closer to home, Canadian banks remain a popular target.
The Canadian government, under Prime Minister Justin Trudeau, will claw back a portion of bank and insurer profits that exceed $1-billion, under a plan called the Canada Recovery Dividend.
And now, grocery chains, such as Loblaw Cos. Ltd. and Sobeys parent Empire Co. Ltd., are under pressure as food prices soar.
The federal NDP brought a successful motion in October that called upon the Competition Bureau to study the grocery sector, which party leader Jagmeet Singh suggested was an example of “corporate greed.”
But now, influential voices are pushing back against the attack on profits, suggesting that political rhetoric isn’t going untested.
“I’m not sure [I] understand the argument for a windfall profits tax on energy companies,” Lawrence Summers, the Harvard professor, tweeted on Tuesday.
Mr. Summers, who was Treasury secretary in Bill Clinton’s administration and director of the National Economic Council for president Barack Obama, added: “If you reduce profitability, you will discourage investment which is the opposite of our objective.”
Others are questioning whether corporate profits are really a significant driver of inflation.
According to Mark Zandi, the chief economist at Moody’s Analytics, 60 per cent of the September reading on U.S. inflation is owing to supply-side drivers such as the Russian invasion of Ukraine, which has driven commodity prices higher. The shortage of housing is another culprit, as is strong demand for consumer services and health care.
But price gouging?
“Corporate greed is a stretch as corporate profit margins, while wide, are declining,” Mr. Zandi tweeted this week.
Second, it’s difficult to see any ingrained predatory behaviour within sectors that are now being scrutinized.
Grocery-store margins are healthy, but they are not out of control.
According to a recent report on the sector by George Doumet, an analyst at Bank of Nova Scotia, the retail gross profit margin at Loblaw – revenues minus cost of goods, divided by revenues – was 29.7 per cent before the pandemic.
He estimates the margin will expand only slightly this year and next year, to 31.1 per cent in both cases. That’s an expansion of just 1.4 percentage points, and may have more to do with returning to the office than rising food prices.
“Grocers that have material pharmacy exposure are currently benefiting from a gradual shift away from work-from-home, leading to increased demand for higher-margin, front-of-store items (beauty and cosmetics),” Mr. Doumet said in his note.
In the case of oil producers, the energy sector is notoriously volatile, rather than a perpetual money-spinner.
When oil futures dipped well into negative territory in April, 2020, amid vanishing energy demand, oil producers reported horrendous results for the year. Exxon Mobil’s annual loss in 2020: US$22.4-billion.
“If it is a fairness argument,” Mr. Summers tweeted in response to Mr. Biden’s attacks on the energy sector, “I don’t quite follow the logic since even with the windfalls Exxon has underperformed the overall market over the last 5 years.”
For sure, Exxon is performing well this year. The S&P 500 energy sector is up 65 per cent in 2022 and Canada’s energy sector has made similar gains.
A sustained rally, though, will depend on commodity prices and economic activity, which remain open questions.
Lastly, the long-held belief that companies should only serve the interests of shareholders may be fading.
Investing based on environmental, social and governance principles, or ESG, is capturing investor assets and the attention of sophisticated investors such as pension funds.
Many companies appear eager to measure up to the new standards.
In 2019, the Business Roundtable, an association of U.S. chief executive officers including Exxon and Chevron Corp., agreed on a new purpose for a corporation – one that takes into consideration the interests of employees, suppliers, customers and communities.
“We commit to deliver value to all of them, for the future success of our companies, our communities and our country,” the Roundtable’s current statement reads.
Critics may roll their eyes. However, it marks a stunning shift from the previous era, defined by University of Chicago economist Milton Friedman’s doctrine in 1970, which argued that “the social responsibility of business is to increase its profits.”
No doubt, companies are still focused on growth. But the concern among critics that some companies may be making too much money seems like a nice problem for investors to have.
David Berman