Data Update 6 for 2026: In Search of Profitability and Value!

Profitability in 2025 & The Impact of AI: A Detailed Analysis

Key Concepts:

• Economic Profits: Cash flows, representing true profitability beyond accounting measures.
• Stakeholder Wealth Maximization: The idea that businesses should maximize wealth for all stakeholders (shareholders, lenders, customers, employees).
• ESG (Environmental, Social, and Governance): A framework for evaluating companies based on sustainability and ethical impact.
• Theocratic Trifecta: Stakeholder wealth maximization, ESG, and sustainability – all share the weakness of prioritizing virtue over profit.
• Moat: A company’s sustainable competitive advantage.
• Excess Return: The difference between a company’s return on capital/equity and its cost of capital/equity.
• Corporate Life Cycle: The stages a company goes through (startup, growth, maturity, decline) and how profitability changes within each stage.
• Opportunity Cost: The potential return lost by investing capital in one venture instead of another.

I. The Fundamental Goal: Profit Maximization

The core argument presented is a reaffirmation of Milton Friedman’s 1970 thesis: the primary social responsibility of a business is to increase profits. While acknowledging evolving societal expectations, the speaker contends that profitability is foundational – without it, a business cannot fulfill other positive contributions. Initial critiques focused on nuances (cash flow vs. profits, short-term vs. long-term), but later challenges became more fundamental, arguing for broader responsibilities to society and the planet. These evolved from adding constraints to profit maximization (being a good corporate citizen) to incorporating these concerns into the objective function itself, manifesting as stakeholder wealth maximization and, subsequently, ESG.

The speaker argues that these alternatives share weaknesses, labeling them the “theocratic trifecta” due to their prioritization of virtue over financial performance. Leading with virtue, he asserts, creates an “us vs. them” mentality hindering improvement. Furthermore, the definitions of these concepts (ESG, sustainability) are diffuse, allowing for inconsistent measurement and potential for “greenwashing.” Crucially, the speaker contends that these approaches falsely promise “goodness without sacrifice,” which he believes is a fundamental flaw.

II. The Rise and Fall of ESG & the Emergence of Sustainability

ESG experienced rapid adoption, fueled by buy-in from major financial institutions. However, the speaker’s analysis reveals that the purported “alpha” (excess returns) attributed to ESG was largely “accidental alpha” – driven by the success of technology companies with inherently low carbon footprints. He found no evidence that adopting ESG practices increased revenue growth, margins, or cash flows, and suggests it may even hinder scalability and reduce profit margins. While ESG offered some potential in risk reduction, this didn’t translate to lower cost of capital.

Consequently, ESG has waned, replaced by “sustainability,” which the speaker views as essentially repackaged ESG – “lipstick on a pig.” He maintains that all these alternatives suffer from the same core weaknesses.

III. Measuring Profitability: Accounting Fundamentals

The session pivots to a practical discussion of profitability measurement, emphasizing the importance of understanding accounting. The speaker outlines the standard income statement structure:

• Revenue – Cost of Goods Sold = Gross Profit
• Gross Profit – Operating Expenses = Operating Profit (EBIT)
• Operating Profit – Interest Expenses + Other Income = Pre-Tax Profit
• Pre-Tax Profit – Taxes = Net Profit

He highlights the convergence of accounting standards (IFRS and GAAP) and stresses the importance of analyzing various profit margins.

IV. Global Profitability in 2025: Data Analysis

Analysis of 48,156 companies globally (5,000 in the US) reveals the following key findings:

• Global Gross Profit: $24.5 trillion (on $72.4 trillion revenue)
• Global EBITDA: $11 trillion
• Global Operating Income: $7.6 trillion
• Global Net Income: $6.1 trillion
• US Contribution: Approximately one-third of global net profits ($2.2 trillion on $19.7 trillion revenue).

Profit Margins:

• Gross Margin: Captures unit economics.
• Operating Margin: Reflects economies of scale.
• Net Margin: Accounts for debt and taxes.
• EBITDA Margin: A proxy for capital intensity.

Sector Performance (Aggregated Margins):

• Most Profitable (Aggregated): Technology, Utilities (US).
• Technology (US): Aggregated margin ~25%, but median operating margin is negative, indicating a highly skewed distribution with a few dominant players driving profitability.
• Low Margin Sectors: Retail, Grocery, Food, Chemicals.

The speaker notes a “topheaviness” in margins across sectors, meaning larger companies contribute disproportionately to overall profitability.

V. Accounting Returns & The Cost of Capital

The speaker differentiates between accounting returns (Return on Equity - ROE, Return on Invested Capital - ROIC) and economic returns (considering the cost of capital). He outlines the formula for ROIC: (Operating Income + Taxes) / Invested Capital (Equity + Debt - Cash).

Limitations of Accounting Returns:

• Year-Specific Events: One-off gains (e.g., precious metals price increases) can distort returns.
• Accounting Classifications: Inconsistent treatment of leases and R&D can skew results.
• Life Cycle Effects: Young companies often show negative returns due to initial investment.
• Inflation: Book values of assets may not reflect current costs.
• Write-offs: Can artificially improve returns.
• R&D Expensing: Understates returns for technology and pharmaceutical firms.

Excess Return: The difference between ROIC/ROE and the cost of capital/equity. The speaker emphasizes that excess returns are driven by sustainable competitive advantages (“moats”).

VI. Excess Returns: Global & US Analysis

• Globally: Only 28% of companies earn more than their cost of capital.
• US: Similar to the global average (around 28%).
• Sector Differences: Technology generally exhibits higher excess returns, while other sectors struggle.
• Company Size: Larger companies are more likely to generate excess returns.
• Corporate Age: Companies in the mature growth phase tend to have the highest excess returns.

VII. The Impact of AI on Profitability

The speaker predicts that AI will, in aggregate, decrease company profitability. While acknowledging AI’s potential to increase productivity and reduce costs, he argues that these benefits will be widespread, leading to increased competition and downward pressure on margins. He draws an analogy to online retailing, where increased efficiency ultimately benefited consumers but harmed many traditional retailers. He anticipates a “slow-motion car wreck” as profitability numbers decline, particularly in sectors like software.

VIII. Conclusion: A Return to Fundamentals

The speaker concludes that, despite decades of debate, Milton Friedman’s original thesis – that the primary goal of a business is to maximize profits – remains valid. He argues that acknowledging this allows for a more honest discussion about how to incentivize businesses to act responsibly. He dismisses disclosure requirements as largely cosmetic and suggests that ultimately, consumers and voters must demand responsible behavior from businesses. He emphasizes the increasing difficulty of achieving sustainable profitability in the current economic landscape and expresses a cautious outlook on the impact of AI.

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