The concern many of us have now is that the activity of central banks will tip the global economy into recession. The US Fed has been particularly aggressive with rate rises. You would imagine that this is where the first domino might fall. For this reason I recently spent ten days visiting major American companies, asking how things are.
Insights from on the ground
My trip was focused on the American Midwest. Most of the cities I visited were growing and excited about the opportunity of reinvesting in industry. Near Columbus, Ohio, Intel is spending $20bn on two giant cutting-edge semiconductor factories that will create thousands of jobs and attract more to the region. The talk was of how America’s coastal cities are becoming overpopulated and polluted. The Midwest cities do not have these problems. They have low-cost energy – and water, too. Employee mobility helps in these circumstances.
Inflation is a global issue. Management talked of problems in the supply chain pushing up costs, but these pressures are receding. Energy prices appear to be falling as well. That leaves wage inflation, but this was not deemed a major issue. Yes, wages are going up faster than they were, but these are companies – often tech companies – for which wages, as opposed to stock-based compensation, are a relatively small part of overall costs. These companies can pass on a proportion of the costs and easily absorb the rest to help preserve their customer relationships. This is because many of these companies have high profit margins.
As active managers, we can focus on such companies. Across both our portfolios, around half of the 60 or so stocks we hold have a 10-year average operating profit margin in excess of 20%. Six of them have a profit margin of over 50%.
Companies we own that I saw on my trip include Thermo Fisher (23.4% operating margin), Mettler-Toledo (23.3%) and Proctor & Gamble (21%).
Profitable companies help protect your portfolio in times of trouble. Companies with high profit margins that are not capital-intensive can be found around the world, but they are more abundant in the US and especially at the top end of the S&P 500 – which is why aggregate P/E multiples are higher. Take Microsoft, for example. It is on a 26.3x forward P/E valuation, but its 10-year average operating profit margin is 34%.
