© 2000 John Petroff
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© 2000 John Petroff |
7)- Is there a benchmark for profitability?
The conclusion that emerges from the forgoing comparison of empirical data for eight sectors in the three previous subsections is that age, size, regulations, operating and financial leverage matter a great deal. Even for a given industry, profits are very much affected by these factors. For instance, the proportion of debt explained why larger firms generate more return to shareholders in utilities, but the reverse in manufacturing.
Another conclusion that emerges from table T-13.2 is that there is much more variability among small firms than among larger firms. This is shown by the size of the standard deviation which is ten times larger for small firms than large firms. For an analyst, this finding indicates that only data for larger firms can be considered reliable in any given year, and if a benchmark must be used, then it would be the profitability (measured by either net profit margin or return on equity) of the group of large firms, i.e. not an average of all firms. If we look at graph G-13.2, there appears to be a convergence of ROE for larger firms somewhere around 24% for five of the sectors (construction, manufacturing, transportation, wholesale and retail). Utilities have a much lower return because they have a stable market. In the remaining sectors, information and services, large firms generate return on equity around 30%. For the information sector, expectation of future earnings in computer services, as well as cable and communication, and their turmoil seem to justify a higher return for a higher risk. But for services, which is more stable than manufacturing or transportation, the higher return is difficult to support in theory.
These conclusion apply only to 1999 data. In recession years, performance of most sectors would be much different except for utilities and certain services, as will be further outlined in next chapter.
See review questions Q-13D7.1 and Q-13D7.2.
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