A Persistent Profit Machine

Fourth-quarter earnings surged again -- and capital outlays point to more growth

Corporate America is producing streams of black ink despite tough economic challenges at home and abroad. Profits for the 900 companies on BusinessWeek's Corporate Scoreboard rose 25% in the fourth quarter of 2004 from a year earlier on a 14% increase in revenue, well above what the experts were expecting a year ago. For all of 2004, earnings rose even faster, climbing 29% as revenues rose 13%.

But there's even better news buried inside the earnings reports. Many companies are reporting big increases in capital spending, especially in the long-suffering industrial and materials sectors, with a gain of 17% in investment for 2004. That spending is likely to boost jobs and economic growth across the board for the rest of this year. Profits aren't likely to keep growing at the gangbusters pace of recent quarters, but the conditions are right for continued expansion.

Starting with this issue, BusinessWeek is taking a fresh approach to the Scoreboard, a popular feature in the magazine since 1973. We're digging into companies' income statements in greater depth, looking for patterns that traditional earnings surveys tend to miss. For instance, this story analyzes capital spending by industry sector -- a vital topic as companies bump up their investment in new buildings, equipment, and software.

Also new in these pages is a look at which industries saw the fastest increases in profits per employee in 2004. The big winners: the materials and information-technology sectors, where profits per worker rose 191% and 81%, respectively, in 2004. Such gains can encourage employers to expand their workforces. We also take a sneak peek at the companies with the highest profit margins in each industry group and a long view of which companies had the greatest cumulative profits -- or losses -- over the past five years. In that category, the prize goes to Exxon Mobil Corp. (XOM ), with a staggering $88 billion in earnings, followed by General Electric and Citigroup.


At the same time, we're moving more of the raw data online. The full Scoreboard listings of 900 companies are available in printable and searchable formats at www.businessweek.com/extras.

Judging from the numbers, the U.S. has truly gotten over the recession of 2001 and the subsequent "job-loss" recovery and is managing to shake off more recent troubles such as high oil prices, the war in Iraq, higher short-term interest rates, sluggish growth in Europe, and big deficits in the federal budget and the trade balance. The fourth quarter of 2004 marked eight straight quarters of double-digit earnings increases. Perhaps more important, 2004 was the first year where corporate profits, as measured by the BW Scoreboard, were above their boom-time peak of 2000. (For purposes of the Scoreboard, profits are defined as net income from continuing operations before extraordinary items such as natural disasters. Our numbers do include the effects of most asset writedowns.)

Our Scoreboard figure of 25% earnings growth is in line with earnings gains for 407 of the companies on the Standard & Poor's 500-stock index that reported through Feb. 14. According to a Bloomberg Financial Markets tabulation, those companies' earnings from continuing operations grew 23.2% in quarters ended November through January compared with a year earlier.

This persistent profit growth is good news not only for the corporate sector but also for the economy as a whole. It's giving executives plenty of cash to invest for the future -- without having to go out on a limb and borrow. Goldman, Sachs & Co. (GS ) industry analysts say cash flow is the first-choice source for financing capital spending at 90% of the companies they follow -- vs. just 3% of companies where debt is the first-choice source.

The paper and forest-products industry typifies the virtuous circle between profits and capital investment. The industry's profits grew 136% last year, to a collective $2.4 billion, boosted mainly by higher prices. Lumber prices in 2004 were up 17% compared with the previous year, despite some softening in the last quarter. Companies then used their improved cash flow to step up capital spending. Take Louisiana-Pacific Corp., the Nashville (Tenn.) lumber and plywood company, which has profited from the continuing boom in residential construction, with earnings up 49% last year. It increased its investment in new productive capacity by 78% last year, to $148 million. In addition, Louisiana-Pacific announced that it was going to build a new wood-panel factory in Clarke County, Ala.


In terms of capital spending, the cutting-edge parts of the economy, like telecommunications, are snapping out of the coma they fell into when the tech bubble burst in 2000-2001. Verizon Communications Inc. (VZ ), the nation's biggest telecommunications company with $71 billion in revenue, saw its profits more than double last year, to $7.3 billion. That made it easy for Verizon to afford a 12% boost last year in its already-hefty capital spending budget, to $13.3 billion. Verizon is sinking the money into projects that should produce higher earnings in the future, such as high-speed network connections. The company extended optical fibers to about 1 million homes last year and aims to reach an additional 2 million homes this year. That investment is entirely aside from Verizon's Valentine's Day announcement of an agreement to buy MCI Inc. for $6.7 billion, which doesn't involve any fresh spending on buildings, equipment, or software.


Add up the numbers, and capital spending by Corporate Scoreboard companies grew 18% for the quarter and 9% for the year. That's based on capital spending reported by 476 companies out of 900 total. This year looks good, too, in spite of the Dec. 31, 2004, expiration of a provision that let companies immediately expense 30% of the cost of equipment and software. Blue Chip Economic Indicators says economists are looking for a 10% gain in capital expenditure in 2005.

To make good money in 2004, it sure helped to be born an oil company. The price of oil averaged over $40 a barrel -- the highest yearly average ever. ExxonMobil topped all companies with $25.3 billion in profits, a 21% increase over 2003. ChevronTexaco Corp. (CVX ) and ConocoPhillips (COP ) also cracked the list of top 15 earners with identical 77% increases in annual profits. Those companies led the energy sector as a whole to a $22 billion increase in annual profits compared with the previous year, the most of any sector.

Similarly, the strong 136% rise in profits in paper and forest products evinced a wider trend in the suddenly hot materials sector, which includes chemicals, metals and mining, and construction materials. Propelled in part by rising demand from China, this sector experienced a combination of higher prices and higher profits. Altogether, total earnings for such materials companies rose by $14 billion.

At the other extreme were the sectors whose profits fell in 2004. Profits fell $5.5 billion in telecom services, dragged down by AT&T's $6.1 billion loss. Profits declined $4.8 billion in transportation, the result of more red ink from airlines, where high jet-fuel prices inflicted much of the pain. UAL Corp. (UALAQ ) alone lost $1.6 billion.

Energy up, telecom and airlines down: The pattern feels familiar. Besides ExxonMobil, ChevronTexaco also made the list of the companies with the highest cumulative earnings over the past five years. The top five-year earners also included three tech companies, three drugmakers, and three financial giants. UAL was among the bottom five, with $9.5 billion in accumulated losses. Lucent Technologies Inc. (LU ), the network-gear maker, fared even worse, with five-year losses of $24.1 billion.

While those businesses rode the tide of their industries, the intriguing companies are those that produced stellar results in excess of the rest of their industry group. Harley-Davidson Inc. (HDI ) rode the popularity of its "hogs" to the highest profit margins in the automobiles and components sector among Scoreboard companies. Equifax Inc. (EFX ), the credit-reporting service, came out on top in commercial services and supplies. EBay Inc. (EBAY ) trounced other retailers -- no surprise, given the low operating cost and high popularity of its online shopping business. Medtronic Inc. (MDT ), which sells pacemakers, had the highest profit margins in health-care equipment and services. And Coach Inc. (COH ), known for its fancy leather goods, had the highest margins in consumer durables and apparel.

What's next for corporate profits? Thomson First Call (TOC ) says that, according to its survey, industry analysts are expecting earnings growth for the S&P 500 companies to slow from its 2004 pace, fluctuating between 8% and 12% each quarter and totaling 9.7% for the year. On the other hand, the experts have been wrong before: In January, 2004, those same analysts were forecasting earnings growth of 14.2% for the fourth quarter. The growth rate now looks more likely to come in at 20%, using First Call's earnings measure.

Will we see strong growth in 2005? The answer comes down in part to whether the profit surge to date emboldens executives to continue expanding. There was a surge last year in the dollars of profits earned per employee. In the materials sector, which includes steel and other in-demand commodities, profits per employee nearly tripled. Information technology saw an 81% increase.

Those rising profits do two things: They give companies the incentive to hire more workers, since their existing employees are paying off so handsomely. They also give executives confidence that investment in equip-ment will be money well spent. And continued strength in capital spending is what it will take to keep this profit cycle rolling forward.

By Peter Coy in New York

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