Morningstar Magazine - December 2017/January 2018 - 8

Dispatches

Why Are Corporate
Profits So Dang High?
A controversial topic that
won't go away.

argue that institutional investors such as
Vanguard need to change the way they invest
to mitigate any incentives they have to
limit competition and reap oligopolistic profits for
fund shareholders.
There's a lot to unpack in the barbarians' argument.
At Morningstar, we're most interested in
what all this means from an investor perspective.
Where the Barbarians Are Correct

Phillips Curve
12

You Get What You Measure

14

Index-Fund Imbroglio

15

The Dividend Discount Model

LETTER FROM THE BOARD

Haywood Kelly

Ivory Towers

The Old Squirrel

Policy
18

Would Policymakers Target Index Funds?
Behavior Gap

20

Reality Check

23

Americas
Greater Europe
Asia

Global Briefs
26
27

The barbarians are at the gate, and you
don't have to strain too hard to make out what
they're yelling:
Monopoly power is on the rise! The largest
companies-among them the new titans of tech
like Amazon, Apple, Facebook, and Google-
are a threat to consumers, and unless the
government acts, their power over consumers will
only grow. Across the board, corporate profit
margins are at all-time highs as competition
declines, fueling the growing inequality between
the rich (who own shares in these companies) and
the poor (who don't). Furthermore, ownership
is becoming increasingly concentrated in the hands
of a few institutional investors that have strong
vested interests to limit competition even further.
Down with these monopolies!
It would be more accurate to say the barbarians
have long since poured through the gate and
are now wandering the streets. Regulators in the
European Union have their sights set on the
U.S. technology giants, much like they were on
Microsoft MSFT 20 years ago. In the United States,
the Democratic Party has made declining
competition a theme that will surely resurface in
the 2018 and 2020 national elections. The
Economist, normally no friend of government
intervention in markets, has run a series of articles
on declining competition, advocating that
the U.S. government dust off its antitrust cudgels.
A cottage industry within academic economics
is studying whether competition is indeed
falling, and if so, why. Law professors, one of
whom we interview in this issue (Page 34),

8

Morningstar December/January 2018

You don't have to be a barbarian to agree
that we live in a period of incredibly high corporate
profits relative to historical levels. We would
even go so far as to say that there's something
to the argument about declining competition.
As usual with markets, both secular trends
and cyclical trends are at play. There are a host
of reasons for the increased profitability
of U.S. companies, three of which I highlight.
1 An Incredibly Auspicious Macro Environment

Not only has there not been a U.S. recession
in eight years, but the entire period since 1980 has
been-relative to the first 80 years of the 20th
century-a walk in the park: falling interest rates,
no world wars, tamed inflation, the disintegration
of communism, and perhaps most important,
the integration of China and India (and their labor
markets) into the global economy. Even our
financial crises have been, in retrospect, temporary
affairs. Witness the quick rebounds in the stock
market after the crash of 1987, the Internet
crash in the early 2000s, and the mortgage crisis
of 2008. Taking the historical view, we should
thank our lucky stars that we have lived through-
and invested through-such an auspicious time.
2 The Amazing Economics of Today's Leading Firms

Never before have companies been able to scale
so quickly-from nothing to a hundred billion
dollars in revenue in a matter of years-
and to do so with so little need for external capital.
That's only possible because of the scale
economies and network effects allowed for by
digital media, the web in particular. The five
largest companies today by market cap-
Alphabet GOOGL, Apple AAPL, Microsoft, Amazon
.com AMZN, and Facebook FB-all enjoy
economic moats. Not only that, but one significant
source of their moats is the network effect,
Table of Contents for the Digital Edition of Morningstar Magazine - December 2017/January 2018
