Revenue Challenge

Before looking at that corporate stock market screen, check out this chart from the Federal Reserve Bank of St. Louis, showing U.S. corporate profits, relative to gross domestic product, from the start of 1947 through October 1, 2020:

In a recent interview, Kimball Brooker, portfolio manager at First Eagle Investments in New York, said that success was “to some degree at the expense of the workforce.”

Brooker went on to say that recent successes in organizing efforts at Starbucks Corp. SBUX,
-1.75%
stores and an Amazon.com Inc. AMZN,
-2.47%
fulfillment center “indicate a shift, where actual labor wages may not have kept pace.”

With steep wage increases at a time of high supply cost inflation, the ability to raise prices is critically important for companies to maintain profit margins.

Consumer inflation hit a new 40-year high of 8.5% in March, while wholesale prices rose 11.2% from a year earlier.

Brooker said companies’ gross margins can “give us a clue to a company’s flexibility. Gross margin primarily reflects direct costs. The higher the margin, the more flexibility a company has to compete and remain reasonably absolutely profitable.

A company’s gross margin is its net sales, less the cost of goods or services sold, divided by sales. Net sales are sales minus returns and discounts, such as coupons. The cost of goods or services sold includes the actual costs of manufacturing the items or providing the services, including labor. This is a useful measure of pricing power, and the combination of an expanding gross margin and increasing sales is a good sign.

Other expenses are included in pre-tax operating margins.

Brooker said a company’s ability to raise prices to cover rising costs could indicate that there are few substitutes for its products or services, or that it has a particular competitive advantage.

“The fewer the substitutes, the better the pricing power,” he said.

Price-power screen

Understanding pricing power is complicated. Higher prices may reflect an increase in the price of a commodity, such as oil, as production break-even points are exceeded. Again, oil does not dominate the results of the next screen, which is designed to narrow down a list of companies that have increased sales while improving profit margins, while not diluting shareholder ownership.

From the S&P 500 SPX,
-1.21%,
we narrowed the list down to companies that met the following criteria, based on data provided by FactSet:

• Higher operating income before unusual items for the most recent quarter compared to the prior year quarter, based on data available at the end of April 13. Any business will have certain fixed costs, even in the gross margin. Thus, an increase in sales beyond a critical level can lead to a sharp increase in operating income.

• Higher sales for the most recent quarter compared to the prior year quarter.

• Expanded gross margin. If we look at this item alone, it is available for 447 of the S&P 500. Gross margins are not available for banks and insurance companies, which use different measures of profitability. These industries are therefore excluded from the screen. Among the 447 companies, 225 (or 50%) had improved their quarterly gross margins year over year.

• Extended operating margin.

• A decline in the average number of shares used to calculate quarterly earnings, compared to the prior year quarter. Increasing the number of shares dilutes the ownership position of shareholders and decreases their share of a company’s profits and cash flow. Among the S&P 500, 269 (or 54%) of companies had a lower average number of shares for the most recent quarter compared to the year-ago quarter.

Here are the 16 S&P 500 companies that posted the largest increases in quarterly operating profit over the prior year, while meeting the other selection criteria:

Company	Teleprinter	Increased op. Income	Quarterly op. revenue ($millions)	Op. revenue – prior year quarter (millions of dollars)	Quarterly gross margin	Gross margin – prior year quarter	Quarterly op. margin	Op. margin – quarter of the previous year	Increase in quarterly sales compared to the previous quarter
APA Corp.	APA, +0.16%	617%	$846	$118	45.15%	18.62%	53.76%	49.96%	89%
Raytheon Technologies Corp.	RTX, +0.87%	563%	$1,234	$186	20.16%	13.46%	13.95%	8.16%	4%
Nucor Corp.	NUDE, +1.28%	436%	$3,029	$565	34.07%	13.67%	31.55%	14.48%	97%
Mosaic Co.	MOS, +1.33%	276%	$1,043	$278	30.37%	15.81%	33.22%	20.48%	56%
Franklin Resources Inc.	Well, -2.33%	270%	$641	$173	73.74%	65.42%	32.07%	14.92%	33%
Micron Technology Inc.	MU, -3.11%	230%	$2,621	$794	47.21%	26.44%	56.04%	37.57%	25%
Bristol-Myers Squibb Co.	BMY, +0.83%	206%	$2,234	$731	60.02%	56.37%	40.64%	31.32%	8%
Boston Scientific Corp.	BSX, -0.41%	163%	$457	$174	62.07%	55.43%	23.89%	17.10%	15%
PVH Corp.	HPV, -1.69%	144%	$207	$85	58.41%	56.95%	11.82%	8.16%	16%
Celanese Corp.	THIS, -1.33%	141%	$516	$214	31.16%	23.32%	26.77%	19.17%	43%
Robert Half International Inc.	RHI, -2.45%	124%	$199	$89	39.06%	38.26%	14.23%	8.00%	36%
Prologis inc.	PLD, -1.39%	122%	$498	$225	46.00%	36.30%	70.09%	57.76%	15%
Expeditors International of Washington Inc.	EXPD, -0.70%	121%	$624	$282	13.85%	12.98%	11.79%	9.94%	81%
Darden Restaurants Inc.	DRI, -0.10%	114%	$292	$136	16.57%	14.39%	15.79%	12.96%	41%
Dow Inc.	DOW, +2.07%	112%	$1,807	$851	17.18%	13.76%	17.14%	14.10%	34%
Advanced Micro Devices Inc.	AMD, -4.79%	108%	$1,212	$584	50.27%	44.73%	27.89%	21.12%	49%
Source: FactSet

Click on the tickers to learn more about each company.

Click here for Tomi Kilgore’s in-depth guide to the wealth of information available for free on the MarketWatch quotes page.

Any stock screen is just a starting point for further research.

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