U.S. after-tax corporate profits, adjusted for inventory valuations and capital consumption, dropped 5.1% in 2015, the Bureau of Economic Analysis (BEA) reported Friday. In the fourth quarter, seasonally adjusted annualized profits fell 8.4% year-over-year, compared to a fall of 1.7% for the third quarter. But the situation for U.S. companies is not as dire as it seems.

Since the beginning of 2010, profits have accounted for an average 9.9% share of GDP, considerably higher than the corresponding figure of 7.3% in the previous decade and 5.4% in the 1990s – and more than double the 4.9% share for the 1980s. Corporate profits have been extremely volatile, but long-run averages show that they are eating up an unprecedented chunk of the American economy. Even their recent nadir, in the final quarter of 2008, wouldn't have been in the bottom third of quarters in the 1980s. 

Are Profits Too High?

This trend toward higher profits might not be a bad thing in itself – particularly for investors – but according to research by the Economist, it results in large part from decreasing competition. Between 1997 and 2012, the Economist found, two thirds of industries became more consolidated, with the top four firms in any given industry going from 26% market share to 32%.

Since 2008, a wave of mergers and acquisitions worth $10 trillion has occurred, allowing companies to cut costs, raise prices faster than inflation, keep wages low and fend off new entrants.

One reason there is not more competition, the magazine argues, is complicated regulation. The more expensive compliance becomes, the greater the advantage big companies enjoy. Despite media focus on "unicorns" such as Uber and Airbnb, startup formation is as low as it's been since the 1970s.  

The Bottom Line

Corporate profits are falling, which could be harmful to markets in the short term. But over the long run, profits have surged as a share of the economy, and the reasons why betray the economy's relative weakness. The normal mechanisms of competition that keep companies on their toes appear to be broken. The Economist argues that regulation is one reason, and there may be others. But while falling profits might seem daunting, investors should keep in mind that if they indicate increasing competition – which is not necessarily the case – that could also mean higher wages and lower prices.

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