Ovid (publius_ovidius) wrote,

Exxon Is Barely Scraping By

pleiade37, who, like me, is also interested in economics, had an interesting post about Exxon's profits. Now, no disrespect is meant towards her, but she linked to this hilarious post in The New Editor, a right-wing blog. In this blog, they point out a couple of interesting -- and misleading -- facts about Exxon's record 11.7 billion second quarter net profit this year.

  1. Exxon was "only" earning 8.5% profit.
  2. Exxon has a price/earnings ratio of less than 11 (I'll explain this in a moment).

To give a quick quote from this:

ExxonMobil just announced their 2008 2Q earnings -- $11.7 billion -- which are being touted by the press as the "highest-ever" profit for a US company -- of course there is either a de-emphasis or no mention at all of the company's profit margin in most of these stories (ed. -- Exxon's 2008 2Q profit margin was just less than 8.5%) -- a number which might add some additional context to the report.

Though they don't come outright and say it, they strongly hint that the profit margin is rather low relative to the earnings. Oh, poor Exxon! Barely scraping by! Oh, but wait a minute; it turns out that this is pretty damned close to average profit margin for corporations for the last couple of decades.

OK, since they only implied that Exxon's profit margin was poor, let's give them the benefit of the doubt and focus on their real mistake:

Here's a question for all those who are bashing Exxon's 'record profits': if Exxon is making 'record profits,' why is the company's P/E ratio below 11? (The average historical P/E ratio for the stock market is roughly 20, less the inflation rate.)

So what the hell is a price/earnings ratio? Well, that's simply the price you pay for a share divided by how much money you'll make annually[1] for it. In other words, if you pay $100 for a share and you earn $5 dollars per year, you have a P/E ratio of 20 and it will take you 20 years to recoup your investment. In other words, if the P/E holds, the number is simply how many years it takes for you to earn your money back.

Now it might seem like the lower a P/E ratio, the better deal you get, but this is where it gets strange. As you can see from the relatively simple math, the lower the P/E ratio, the faster you earn your money back. But here's what happens. If a solid company has a low P/E ratio, people buy up their shares like mad and this pushes the price up. As a result, if a P/E ratio is suspiciously low and remains that way, the market is betting against the company maintaining those profits. So to recap: Exxon is earning record profits, but the market still doesn't trust them. Mind you, "the market" is comprised of people who tend to make their living this way. When they are betting against someone as solid as Exxon, something serious is afoot.

And this is what is happening to Exxon. Exxon didn't meet market expectations. People think that oil company tax breaks are going away. There's also the Exxon shareholder revolt to contend with. Exxon's "what global warming?" approach to climate issues is leading people to the conclusion that Exxon's long-term business strategy isn't viable. And hell, if you have a P/E of 11 and thus know that it will take 11 years to recoup your investment in the fact of radical market change that the company is ignoring, do you really think you're going to feel comfortable with that?

The writers at The New Editor don't appear to factor in these issues, but hey, economics is hard; let's go shopping!

As a side note, even if their 8.5% profit is low compared to other companies, need I remind you that this isn't your typical company? Would you want to earn 10% on millions or 8.5% on billions? Let's have a sense of scale, people.

And if you've read this, you understand why I'm still single in the UK. Who the hell wants to talk about this?

1. Amusingly, I misspelled that at first and Firefox tried to correct that as "anally". I swear my browser has a sense of humor.

Tags: economics, politics
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