Red Lobster recently decided to reverse its year-old policy of requiring servers to handle four tables apiece, rather than the previous three tables. Apparently, the decline in worker and customer satisfaction from the increased work load more than offset the savings in labor costs.
As U.S. corporations cling to the cash on the balance sheet and continue to struggle growing revenue in a stagnant recovery, the record corporate profit levels of recent years may be running into a wall.
In the most recent quarter, companies are beating their earnings estimates, but the revenue growth isn’t keeping pace. According to a recent Bank of America Merrill Lynch report, 56% of S&P 500 companies have beaten expectations on EPS (earnings per share) while only 44% have beaten on sales. Overall, analysts were expecting sales to decline 0.4% on a year-over-year basis in the first quarter while earnings were expected to increase 3.4% year-over-year. The sectors with the best performance in revenue growth year-over-year while also exceeding expectations are consumer discretionary and utility stocks.
If cost cutting is indeed reaching its limits, the companies with revenue growth opportunities should be the beneficiaries. As we evaluate current equity positions and search for new ideas, we will be looking for companies that are growing the top line as well as the bottom line. As Red Lobster’s parent company, Darden Restaurants (DRI), has discovered, at some point cost cutting becomes counterproductive to profit growth.
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