“There’s been a lot of talk about corporate profit margins hitting record highs. (More on this later.)
UBS’s top equity strategist Jonathan Golub is out with new research today, warning that the risks to investing in stocks these days are weighted to the upside.
“[I]t increasingly appears that our very reasonable expectations for earnings and multiples may prove conservative,” he wrote.
His current year-end S&P 500 target is 1,475.
The source of upside surprise: profit margins.
We expect earnings growth of 5.2% in 2012 and 8.7% 2013. A weaker dollar, higher oil prices, and improving foreign sales could provide upside revenue surprises. Additionally, rising capacity utilization rates could drive operating margins to new highs.
Here are the charts he supplied:
UBS
“Margins are driven by capacity utilization”
UBS
“Higher commodity prices are consistent with higher margins”
Golub’s argument tying capacity utilization to profit margins is a simple and elegant one.
But is it too simple?
Many experts have sounded off on the profit margin issue, overwhelmingly arguing that margins are topping, or that they have already topped.
GMO’s James Montier tied record margins to soaring government deficits. Building off of Montier’s work, John Hussman and BI’s Henry Blodget have argued that margins have peaked. Morgan Stanley’s David Greenlaw warned that the flattening of GDP combined with falling unemployment rates mean productivity is falling, which implies falling profit margins. Goldman’s David Kostin doesn’t see a collapse, but he sees margins coming in lower than the rest of the street.
To be clear, Golub isn’t committing to this call for higher margins. Rather, he is just pointing out that it’s an upside risk.”
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