Here's The Problem With 2010 Earnings Forecasts: They Ask For Way Higher Margins Than We've Had In History

Here's The Problem With 2010 Earnings Forecasts: They Ask For Way Higher Margins Than We've Had In History: "

Hate to rain on the bull parade, but this chart from Citi's global strategist Robert Buckland is just unnerving. It shows how profit margins didn't really fall very low during the recent economic downturn. As seen below, they didn't break below 5%, remaining well above the 30-year average of 4.5% according to Mr. Buckland.

Worse yet, analyst earnings forecasts for our current rebound are heavily dependent on margin expansion and are hoping for margins to be higher than any time ever, except for the brief 2005 - 2007 period. Higher than the late nineties even.

Mr. Buckland doesn't seem too concerned:

Citi: We don’t believe margins are destined to fall back down to historical averages, or below, over the next two years. Neither do we think they will push much higher than 2007 levels of 8%. However, our expectation of a sharp rebound in profits (driven by the combination of a subdued revenue recovery and a low cost base) can drive margins ahead over the next two years.

We're pretty sure Citi has a far more detailed view of margins on a company-by-company basis than we do, but from our vantage point 30,000 above betting on essentially all-time high margins seems dangerous. The economist in us wonders why global profitability would suddenly jump to a new, higher long-term level (above the 4.5% of the last 30 years).

As shown below, margin expansion (in black) is a huge part of forecast earnings growth over the next two years. Seems like there could be a lot of room for disappointment in 2010:

(Via Citi, Global Equity Strategist, Robert Buckland, 20 January 2010)