“It’s dangerous to underestimate Corporate America,“ wrote Savita Subramanian, Bank of America’s head of U.S. equity strategy, in a Tuesday note that explores “What could go right for the S&P 500.”1

Among the handful of topics she addresses is corporate America’s sometimes stunning ability to maintain and even improve profitability even under the most difficult circumstances.

Specifically, she addresses the S&P 500’s robust profits despite supply chain disruptions and the rising costs of goods and labor – a trend that has caught analysts on their heels.

Labor efficiency begets profits

“S&P 500 companies are 70% more labor efficient than they were in the 80s,” Subramanian observed. “Today’s labor shortages and onshoring initiatives would likely incent companies to automate, driving further efficiency gains.”

Indeed, we know companies are already in the process of ordering a lot of machinery. And while this looks like bad news for workers employed in labor-intensive industries, for what it’s worth, there are still 10.4 million job openings out there.

Bottom line: Companies are doing more with less.

Pricing power begets profits

“Reported net margins (ex-Fins) so far also surprisingly expanded QoQ (+150bps), pointing to companies’ ability to pass through accelerating cost inflation via pricing,“ Subramanian observed.

Yes, companies will raise prices so long as customers are willing and able to pay.

One recent notable example is McDonald’s, which has raised menu prices by an average of 6%.

“We haven't seen, I’ll say, any more resistance to our price increases than we've seen historically,” McDonald’s CFO Kevin Ozan said last week (via The Transcript). “The 6% has been pretty well received by customers."

Bottom line: Companies are making their customers pay for higher costs.

Operating leverage begets profits

“Supply issues could last for a while, but demand remains robust, which supports solid margins despite challenges,” Subramanian wrote. “Over the past decade, sales growth explained over 50% of margin expansion.“

Back when I was co-writing Yahoo Finance’s Morning Brief newsletter, my co-author Myles Udland predicted that the buzziest phrase in markets in 2021 would be “operating leverage.”

Operating leverage is exactly what Subramanian is talking about here: It’s the driving force behind the record profit margins corporate America has been reporting this year.

Operating leverage is the degree to which a company can increase sales without increasing costs. If a company can increase sales without a significant increase in costs, then it’s benefiting from operating leverage.

Bottom line: Companies have operating leverage, which means a little bit of sales growth is translating to a lot of profit growth. And demand is robust.

Big picture

In a piece I published on Monday, I discussed how companies will go to great lengths – sometimes troubling lengths – to meet aggressive profit targets.

This means reacting to the changing macro environment. If there aren’t good job applicants, then businesses will install robots. If costs are going up, then businesses will raise prices.

And this isn’t just about profit margins either. Think about all changes businesses made during the pandemic to generate revenue. When customers couldn’t come into stores, businesses expanded curbside pickup. When a team couldn’t meet in the office, they met on Zoom. When anchors couldn’t do the news from the studios, they broadcast from home.

Corporate America doesn’t rollover when confronted by challenges. It figures things out, improves processes, and grows.2 This is at the heart of why stocks usually go up over time.