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Profit growth expected to take breather

The booming growth of corporate profits in America isn’t so explosive anymore.

Earnings at big companies grew as if they were on steroids for two years after the worst of the recession - much faster than the economic recovery itself.

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But market analysts are expecting much slower profit growth when leading public businesses begin posting quarterly financial reports Tuesday.

Companies that make up the Standard & Poor’s 500 index are forecast to post a collective increase in earnings of about 3.3 percent for the first three months of the year, according to Thomson Reuters.

Other estimates vary, but they all forecast low to no profit increase for the S&P 500 companies during the quarter, compared with the same period last year.

A few points of comparison: Profits at those companies grew by 9 percent in the final quarter of 2011.

And in each of the three earlier quarters last year, earnings jumped anywhere from 12 to 19 percent. That pace of profit growth was even more dramatic in 2010.

Gains like that have helped big companies become more profitable than ever. Those same S&P 500 companies earned a combined $88.18 per share in the relatively good times of 2006 and saw earnings sink to $60.80 in 2009.

Then business fortunes started to improve and those companies made $97.82 a share last year - more than what they made in their peak years before the recession.

Profits drive the stock market, and both have recovered hand-in-hand since 2009.

The S&P 500 stock index jumped 12 percent during the first quarter of this year but has since retreated modestly as the new corporate earnings season approached.

Investors and economists don’t argue much with these latest forecasts. The real debate: Why is profit growth slowing down now and what does that mean for the future? Are we about to see a temporary blip on the screen or the beginning of the end of a very profitable business cycle?

“This deceleration of earnings growth is due to two temporary factors,’’ says Jim Swanson, chief investment strategist at MFS Investment Management in Boston.

“One is recession in Europe, and the other is this relentless rise in gas prices,’’ Swanson says. “I’m not concerned that the business cycle is at an end and the earnings story is over. I think this is a temporary, two-quarter phenomena.’’

Swanson points out that nearly 10 percent of sales by companies in the S&P 500 come from Europe, where he believes a recession will be mild and brief.

He looks at oil stocks to anticipate the future price of gas and concludes: “The market is saying we’re peaking now.’’

But the growth trajectory of corporate profits is also running into some basic facts of business life.

After many quarters of big percentage gains, the profit comparisons become increasingly difficult to beat. The law of big numbers will catch up with every business sooner or later.

Another factor: Companies grew profits much faster than the economy expanded because they cut costs so deeply.

That led to huge profit margins, but there are limits to those potential savings. Eventually, business profits begin to trace the relatively modest trajectory of the economy.

The smaller profit gain forecasts “are entirely consistent with a 2.5 percent type of gross domestic product number,’’ says Leo Grohowski, chief investment officer at BNY Mellon Wealth Management in Boston.

“The reason earnings growth is going to slow is that efficiency and productivity gains get harder to come by and comparisons are more difficult,’’ he says.

Grohowski points out that the first-quarter fortunes of companies will vary and many will continue to report big gains in earnings.

But the performance will vary widely from one sector of the economy to another.

Among 10 leading industry groups, analysts estimate three will post lower profits, and the others will report bigger earnings.

But all of those sector gains are expected to be muted. The biggest gain of 10.6 percent - forecast for industrial companies - doesn’t look very dramatic compared with the gains of 2011.

Business profits may very well be under pressure from temporary factors that will fade later in the year.

But the very low cost of doing business in recent years - whether that means the cost of labor or the rate of interest on borrowed money - can’t go much lower and will surely rise in the future.

Steven Syre is a Globe columnist. He can be reached at syre@globe.com.
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