Copper prices are rising.
Scott Olson/Getty ImagesHigher commodity prices are thought to be bad for stocks because they raise input costs, and should, as a result, hurt profitability. That is largely not the case, however. In fact, data show that profit margins rise when commodity prices increase.
The cost of raw materials has surged of late. The price of crude oil is up more than 30% year to date. Copper is up more than 14% for the year.
Consumer demand is strengthening—trillions of dollars of government spending is aiding that—as states reopen. Companies are preparing capacity to meet as much demand as possible and rushing to buy raw materials, sending prices of those goods higher, which drags on profit margins.
That isn’t what usually happens. Data from Credit Suisse ’ show a tight correlation between the direction of industrial commodity prices and that of operating margins. As commodity prices have spiked, the operating margin for the average S&P 500 company is expected to rise to almost 16% for 2021 from 14% in 2020.
“Higher materials costs mean higher operating margins,” Jonathan Golub, chief U.S. equity strategist at Credit Suisse, wrote in a note.
One reason is because the price of commodities often reflects economic growth. When the economy is turning a corner, as it is now, growth in companies’ sales speeds up. A big share of costs at many manufacturing companies are fixed, so every extra dollar of revenue brings even more in additional profits. Higher input costs don’t help, but they are overpowered by the margin tailwinds.
Companies with competitive products are particularly well placed to benefit as demand strengths because they find it easiest to pass along higher costs.
The question now is whether commodity prices have run hot enough to cause margin estimates to come down a tick, which would hurt forecasts for earnings per share. So far, though, estimates of EPS have risen by a few percent, according to FactSet data.
Industrials are among the companies that see expanding profit margins and higher sales in an inflationary environment. Boeing (BA), Emerson Electric (EMR), and Textron (TXT) are on that list.
Another way to benefit from higher prices, and avoid the risk of pressure on margins, is to buy commodity producers. Oil stocks are perfect examples.
The average stock in the Energy Select Sector SPDR exchange-traded fund (XLE) is expected to see its 2021 operating margin jump to 7.8% from negative 4.5% last year, when oil producers were posting heavy losses. Copper miners are in a similar boat. Freeport McMoRan (FCX) is expected to see its operating margin rise to 33% from 17% year-over-year.
All of these stocks are already up between 10% and 40% year to date. The S&P 500, meanwhile, is up 3.8%.
The point is that profit margins are barely threatened, so inflation of the prices producers pay is unlikely to be a sore point for stocks.
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March 11, 2021 at 07:30PM
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Higher Commodity Prices Are Good for Profits, Not Bad - Barron's
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