Inflation likely to hurt profit margins

US earnings season is under way. Earnings have remained robust thus far in 2022, but history suggests investors should be alert to falling profit margins. That’s according to a recent Barclays note cautioning that periods of high inflation tend to be bad for margins.

Indeed, the decline in profit margins during inflationary periods tends to be noticeably worse than periods where revenues contract.

In other words, even if revenues hold up, investors should still brace for declining margins.

Stocks have already tanked this year, so is this already reflected in market prices? Perhaps not — Barclays thinks that “neither managements nor investors are appreciating” the risk to margins. S&P 1500 estimates suggest margins will improve “markedly” in 2022 and decline only slightly in 2023. Importantly, earnings conference calls show a record number more chief executives are talking about margin improvements than are mentioning margin declines.

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This is the first serious round of inflation since the 1980s, says Barclays, so most company managers don’t have working experience in navigating an inflationary environment. During their lifetimes, rising revenues were associated with rising margins. The problem is that inflationary periods are different. Management talk about expanding profit margins, says Barclays, suggests they may not be appreciating the rising risks.