September 2023

To Our Business Partners


We use this term from time to time to describe how competitive forces in our economy generally push and pull economic activity, i.e. corporate profitability, profit margins, revenue growth and other measures of economic health, toward long-term averages.  The process normally involves movements that travel well above those averages and also well below average.  Rarely do these metrics fall on the average; they spend most of their time above or below.  For quite a few years now, due to the favorable economic tailwinds, measures such as profit margins and returns on capital have trended substantially ABOVE average.  The same can be said for valuation measures such as price-to-earnings ratios. Profit margins (income as a percentage of revenues) are now 60% higher than their long-term average.  At the same time, price-earnings ratios are also 60% higher than their long-term average, and price-to-sales ratios are over 2 times higher than their long-term average!

One could argue that the higher profit margins justify paying more in stock price for each dollar of sales or earnings.  But one must believe that profitability will stay higher for the foreseeable future and beyond.  The evidence so far isn’t very promising.  Companies are experiencing higher costs of doing business.  For example, labor costs, while they vary by industry, are many times the highest percentage of total costs.  After many years of declining labor costs, companies are starting to see an explosion in those costs, as demonstrated by the recent UPS and American Airlines contracts and the current auto strike.  These will permeate througout the economy.

Our concern is that profitability is being squeezed at the same time that stocks are selling near all-time high valuation measures.  While this has been a concern for some time, we are finally starting to see it materialize.  If margins are contracting at the same time earnings multiples are also contracting, it would suggest that future stock returns will eventually fall BELOW average. This reversion to the mean (average) has historically been a very powerful phenomenon.  We joke that long-term averages exhibit “a strong gravitational pull.”  While a number of factors have been at work in recent years to offset, it should not be ignored. These are things we pay particular attention to on a company by company basis, and try to commit capital only when these factors are favorable.


Our group of widely-held stocks* is still a “90-cent dollar,” which yields a nominal rate of return over a 3-5-year time horizon, and not much better than cash.  We’ll soon be adding bargain-priced companies to the list, which will boost future portfolio returns.  While we remain highly disciplined, we appreciate your patience!


Stock market indexes declined 2-5% in August, with the smaller company indexes experiencing the larger declines. All the popular indexes remain up for the year to date, but the range remains very large.  The DJIA has gained about 5%, while the NASDAQ Composite is up about 34%. The pattern is similar over the last 12 months, with the S&P 500 and NASDAQ leading the way, up 14% and 19%, respectively.  The small and midcap indexes have gains of 4-8%. One very interesting phenomenon is that indexes in which the component stocks are EQUALLY weighted are up only 2½ to 3½% so far in 2023.  Thus, “The Market” is not doing nearly as well as the capitalization-weighted popular indexes listed above. Our group* of portfolio stocks have favorable returns compared to the indexes in the periods discussed.

Steve Nichols, CFA • Bill Warnke, CFA •  Andy Ramer, CFA

*The group of “portfolio stocks” — our Equity Composite for the purpose of evaluating investment performance — consists of 19 stocks that are held in our clients’ accounts. Portfolios might hold some or all of these stocks, depending on investment guidelines unique to each client, the timing of purchases and sales, and start dates of accounts. The performance of this group of stocks is a good proxy for our equity performance but might vary widely among accounts. Of course, past performance is not necessarily indicative of future results.

We hereby offer to deliver to you without charge a copy of our current Form ADV Part 2, in accordance with the U.S. Securities and Exchange Commission’s “Brochure Rule.” Please contact us if you would like us to send you a copy.