At an Ashburton Investment conference in February last year, a speaker from Morgan Stanley Investment Management was elaborating on profit margins in US-listed stocks. At the time, the average profit margin of S&P 500 stocks was at record levels.
Morgan Stanley’s theory was that this was not sustainable and that margins would shrink in the quarters ahead, potentially sending stocks lower.
Last week, Charlie Bilello of Creative Planning posted a chart of net operating margins. They had not shrunk in the previous 18 months; instead, they had expanded well into record territory, and the estimate for the second quarter of 2026 now sits at 16.7%. It was just above 13% last year when Morgan Stanley was suggesting caution.
Here’s the thing about margins. They simply cannot remain elevated because any industry with an overly wide margin will invite competition.
Say a widget costs R50 to make and I sell it for R100. A competitor is going to look at that juicy profit margin and think: “Heck, if I just sell at R75, I undercut that price and still make a ton of profit.”
This is Capitalism 101. Or so you’d think. In fact, the Bilello chart included this quote from Jeremy Grantham: “Profit margins are probably the most mean-reverting series in finance, and if profit margins don’t mean-revert, then something has gone badly wrong with capitalism. If high profits don’t attract competition, there’s something wrong with the system.” Admittedly, I had to look up who Grantham is (he’s well into his 80s, a British investor and co-founder and chief investment strategist of GMO LLC).
So, what’s going on here? Is the system broken or do we live in a new world of super-margins that can’t be competed against?
Well, it turns out there are a few moving parts. For example, Alphabet reported a Q2 net margin of 93.6%. But that includes gains on the SpaceX shares it holds. When that holding is removed, margins crater back to a more normal 29%. (The ASU 2016-01 law stipulates that paper profits — shares you hold that have risen but haven’t sold — now go straight through profit, even though no cash has flowed.)
There are also some structural reasons, such as the increased weighting of ICT services in the index over the past few decades. These have by nature much higher margins than, say, manufacturers.
Lower corporate tax rates have also helped move margins higher, as has the concentration of a few massive-margin businesses (Apple and Nvidia, for instance).
Checking in on Grantham, he’s of the view that AI won’t move profit margins higher than they typically are, saying: “When the smoke clears, any new technology is merely a cost of doing business.” So the margins will revert in time. Capitalism is not broken after all.
