Small Companies Aren't Sharing in the Corporate Boom
(Bloomberg Opinion) -- For big American corporations — General Electric Co. excepted, of course — these are pretty close to the best of times. Profit margins for the Standard & Poor’s 500 Index companies are near their all-time highs. Heck, profit margins for all of corporate America are near their all-time highs:
This robust profit performance makes it hard to get all that worked up about the current valuation of U.S. stocks. The price/earnings ratio of the S&P 500 is, at 20.6 as of Monday morning, not exactly cheap by historical standards, but it’s not crazy expensive, either.
Not all corporations are doing so well, though. Smaller public companies, defined here as the constituents of the Russell 2000 Index, are on the whole eking just out a modest profit.
It’s apparent from the above chart that small companies have always been less profitable than big ones. But the divergence in fortunes has been growing through the decades, which you can see more clearly if you look just at the gap between the profit margins of the Russell 1000 Index, which includes approximately the biggest 1,000 U.S. companies by market value, and the Russell 2000, which is made up of the next 2,000.
This trend may be partly the result of changes in how corporations are financed and how businesses are organized. The number of U.S. public corporations has more than halved since 1996, to 3,616 from 7,439, according to the Center for Research in Security Prices at the University of Chicago’s Booth School of Business. And the share of business receipts accounted for by limited partnerships, limited liability companies and other pass-through entities that aren’t taxed as corporations grew from 13.2 percent in 1980 to 38.6 percent in 2013, according to the Internal Revenue Service. So maybe some of those small-company profits have simply disappeared from the stock market, not the economy.
It’s not only that, though. The shift in economic activity toward bigger businesses also shows up in Census Bureau data that ignores such financing and organizational choices. The big really have been getting bigger or, in this case, more profitable. And while companies do join the ranks of the big, of course — the S&P 500 and Russell 1000 don’t consist of the same stocks that they did in 1995 or 2005 — the pace of turnover has actually been slowing.
This rich-getting-richer trend feels like the kind of thing that can’t go on forever. Political backlash against corporate bigness, technological changes that favor upstarts or some other obstacles will surely arise. The “Nifty 50” companies, beneficiaries of a similar trend in the late 1960s and early 1970s, did eventually fizzle on the stock market. But “eventually” can take a while, and in the meantime, big companies are driving a sustained profit boom that underpinned the U.S. stock market’s rise through early this year and — as crises in Europe and some emerging markets spook investors — may underpin it some more in the months to come.
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