Rational Investing: Defending Big Oil: Congress misunderstands profit margins

Based on the low approval ratings for Congress and the president, one has to imagine that political uncertainty weighs on the minds of many investors. And like the magician’s tool of misdirection when vanishing objects, congressional misdirection now appears as we are witness to the manipulation of financial numbers so that culprits responsible for oil prices can be brought to task.

Public misguided

I don’t like paying $60 to fill the tank on my car – who would? But let’s see some honesty, not misdirection, when dealing with energy costs.

Ah, sweet misdirection and the magic of large numbers, a concept that some – most certainly our elected senators and representatives – are either unaware of or simply choose to ignore. Railing against the oil companies in the “Made for Public Pandering Show,” the committee that called the hearings on the high prices for crude oil and gasoline lambasted the multibillions in earnings that the oil companies reported.

Although I will admit that I did not watch all the hearings, I did not hear, nor did any of those I queried about the matter, a reference to either what those obscene profits related to in per share earnings or, even more telling, profit margins.

The math is easy – even for elected officials. If my company has a profit of 8 percent on $1 million in sales, it will produce earnings of $80,000. But what if it has $100 million in sales and the same profit of 8 percent? You may be thinking, “Do the math, dummy, it would provide earnings of $8 million.”

Yep, you’re correct. It’s the same percentage of profit, but the larger sales figure means the earnings will be larger in absolute terms. Folks, this is not a difficult concept to learn – at least not for most of us.

Combine this bit of congressional innumeracy with the absence of a coherent energy policy, the ill-advised ethanol-from-corn feel-good legislation, and lack of understanding of the law of supply and demand, and what do you get? You get politicians pointing fingers at that mean old “Big Oil.” Perhaps, as the adage goes that when you point a finger at someone you have three fingers pointing at yourself, they might try a bit of rational reflection on their own actions and the consequences thereof.

Real windfalls

Taking innumeracy a step further toward enlightenment, let’s look at the profitability measurement of profits as a percentage – not absolute dollars – and see if companies other than “Evil Oil” should be considered for a windfall profits tax.

Just for the heck of it, take a shot at ranking the following companies from highest to lowest in terms of percentage profits: Microsoft, Coca-Cola, Intel, McDonald’s, Pepsi, Proctor & Gamble, Exxon Mobil and ConocoPhillips

OK, so it is sort of a trick; they are ranked in descending order of percentage profitability, with Microsoft at the high end at 28.33 percent, Coke right behind at 20.64 percent, followed by Intel’s 17.32 percent, Pepsi’s 14.11 percent, Proctor and Gamble’s 13.9 percent, and then the egregious profiteers Exxon Mobil and ConocoPhillips at 10.85 percent and 6.75 percent, respectively.

I will stay home and watch the hearings if either the Senate or House decides to question – make that “grill” – Coke, Pepsi or Proctor & Gamble about their obscene profits.

Clark Davis is a 37-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money-management company. He can be reached at cdavis@slia.com.

Understanding Innumeracy

In a Los Angeles Times review of John Allen Poulos’ book, “Innumeracy,” critic Lee Dembart wrote, “He notes correctly that the public’s failure to understand chance phenomena, statistics, probability and the nature of many numerical assertions opens the way for all manner of belief in nonsense. Perhaps more important, it leads to distortions in the making of public policy.”[[In-content Ad]]