Returns for domestic nonfinancial business.

Hodge, Andrew W. ; Corea, Robert J.

THE RETURNS to domestic nonfinancial corporations declined in 2009, before and after taxes, for the third straight year, according to statistics from the Bureau of Economic Analysis (BEA). In addition, a similar measure of profitability for nonfinancial industries--a measure that includes proprietors' income--fell in 2008, the most recent year for which these statistics are available.

Once a year, BEA presents aggregate rates of return for domestic nonfinancial corporations, nonfinancial industries, and a few major industry groups--mining, utilities, and construction; manufacturing; wholesale and retail trade; and "other" nonfinancial industries. In addition, various Q ratios, which compare the financial market value of assets with their replacement costs, are also presented.

The broad measures of profitability defined below and discussed in this article may be useful to economists and policymakers. They show which industries have rising or falling returns. They show the relative volatility of returns. Sector performance is now available through 2008, and corporate returns are available through 2009. Thus, the statistics presented in this article show effects of the recession that began in December 2007. (1)

In addition, these statistics incorporate improved statistical measures from the 2009 comprehensive revision of the national income and product accounts (NIPAs) and the 2010 comprehensive revision of the annual industry accounts. (2)

The returns in this article are calculated as the ratio of the net operating surplus to the net stock of produced assets. For nonfinancial corporations, the net operating surplus is the return accruing to capital after labor costs, intermediate inputs, and consumption of fixed capital are deducted from receipts. The net operating surplus is defined as the sum of corporate profits, net interest, and business current transfer payments (table 1). (3) Produced assets refer to the net stock of capital plus inventories valued at current cost.

The corporate data are based on preliminary estimates from the NIPAs and the fixed assets accounts. The statistics on industry returns are calculated using data from the annual industry accounts, the NIPAs, and the fixed assets accounts. To calculate the Q ratios, additional data were drawn from the Federal Reserve Board's flow of funds accounts.

Corporate returns

In 2009, the rates of return for nonfinancial corporations, both before and after taxes decreased for the third straight year. Before taxes, the rates of return fell for the third straight year to 7.4 percent in 2009 from 7.9 percent in 2008 (chart 1 and table 2). The rate of return peaked in 2006 at 10.1 percent and bottomed at 6.5 percent in 1982. After-tax corporate rates of return fell from 7.5 percent in 2006 to 5.7 percent in 2009.

Other measures of profits--such as BEA's measure of corporate profits from current production--have shown a rising trend over the last 30 years. The measures presented in this article exclude the volatile financial sector and compare returns with assets rather than with GDP or corporate value added. Assets have grown faster than either of these two alternative measures over the period, and returns on assets have remained in a stable range over the last 30 years as shown in chart 1.

Current-cost nonfinancial corporate produced assets--the denominator in rates of return--continued to grow in 2008 and 2009 as shown in table 1. In contrast, current-dollar GDP and corporate value added both declined in 2009 after increasing in 2008. So about a third of the 2.7 percentage point drop in pretax returns from a peak of 10.1 percent in 2006 to 7.4 percent in 2009 was due to continued growth in the capital stock through this recessionary period.

[GRAPHIC 1 OMITTED]

Industry returns

Rates of return can also be calculated for industry aggregates using data from the annual industry accounts, which provide annually updated data on 65 industries that together account for total economic activity. Like rates of return for nonfinancial corporations, rates of return for nonfinancial industries are also calculated as the ratio of net operating surplus to produced assets.

Like nonfinancial corporations' net operating surplus, nonfinancial industries' net operating surplus consists of corporate profits, net interest, and business current transfer payments. However, it also includes proprietors' income, which reflects the income of sole proprietorships and partnerships. (4) For this article, real estate, which includes owner-occupied housing, is excluded from the nonfinancial industry data--the net operating surplus and produced assets--to allow for a better comparison with the nonfinancial corporate returns data, which do not reflect home ownership.

The pretax rate of return for total nonfinancial industries declined to 13.0 percent in 2008 from 14.1 percent in 2007. The annual industry accounts do not provide after-tax data. The industry rates of return for 2009 will be available when the annual industry accounts are updated in the fall of 2010.

[GRAPHIC 2 OMITTED]

Most of the difference between the total industry rates of return and the corporate rate of return can be attributed to the inclusion of proprietors' income in industry net operating surplus. However, several statistical differences between the annual industry accounts and the NIPAs also affect the estimates. Notably, the annual industry accounts include adjustments that (1) exclude the financial services-producing establishments of primarily nonfinancial corporations and (2) include the nonfinancial services-producing establishments of primarily financial corporations as well as a share of the NIPA statistical discrepancy. Despite the differences between the total industry rates and the pretax corporate rates, the annual patterns of change of each are similar (chart 2).

Specific industry groups

Returns were also updated for four broad nonfinancial industry groups: mining, utilities, and construction; manufacturing; wholesale and retail trade; and "other" nonfinancial industries (chart 3).

In 2008, the rates of return for all four groups declined as the economy slowed. The sharpest decline was in the manufacturing group; the rate of return fell 2.1 percentage points to 16.4 percent in 2008 from 18.5 percent in 2007, but it remained in the high range relative to the other groups. Manufacturing was the only industry group with a rate of return for 2008 that exceeded its value for 1998. Returns for the wholesale and retail trade group have fallen for 5 consecutive years, with the largest annual decline in 2008. Returns for the mining, utilities, and construction group declined 0.5 percentage point in 2008 to 8.8 percent, its lowest value in the period covered in this article. The rate of return for the "other" non financial industry group fell 0.8 percentage point to 14.8 percent; the rate of return has ranged between 14.5 percent and 16.5 percent over the last 7 years.

[GRAPHIC 3 OMITTED]

Returns were also calculated for the information-communication-technology (ICT)-producing industries. (5) Returns to ICT-producing industries, which have been in an elevated range of 19 percent to 24 percent over the last 5 years, decreased 0.8 percentage point to 19.0 percent in 2008 from 19.8 percent in 2007.

Users may find these consistent series of sector returns and capital stock helpful for comparative studies. For example, from 2004 to 2008, ICT-producing industries had returns that were above the national average, while their average annual produced asset growth was only 4.5 percent, the smallest percentage increase of the reported sectors. Conversely, the mining, utilities, and construction group experienced the lowest average rate of return, but it achieved the highest average percentage growth in produced assets, which grew at an annual rate of 11.0 percent.

Q ratios

"Tobin's Q;' or simply "Q," is the ratio of financial-market valuation of corporate assets to the current-cost value of the assets. A Q ratio above 1 indicates that financial markets value corporate assets above their replacement costs. A value of Q below 1 indicates that the financial markets value corporate assets below the corresponding replacement costs.

Three Q-type ratios for domestic nonfinancial corporations are defined as follows:

* Q1 is calculated as the market value of outstanding equity divided by the net stock of produced assets.

* Q2 adds the book value of outstanding corporate bonds to the numerator used in Q1. (6) The inclusion of bonds makes Q2 a more complete measure of invested capital, but including them at historical cost is clearly inconsistent with the underlying rationale for Q, which is to provide a comparison of market valuation with replacement cost.

* Q3 adds an estimate of the market value of outstanding corporate bonds and net liquid assets to the numerator used in Q1. It also subtracts land from the numerator (because land is not included in the denominator). (7)

* All three ratios reached record levels in 1999, dropped sharply in 2000, and continued decreasing until 2002 (chart 4 and table 3). In 2003, all three ratios began rising. In 2008, they fell sharply, reflecting the massive stock market decline, though both Q1 and Q3 fell below 1. In 2009, the stock market recovery more than offset the small continued capital stock gains noted earlier. The Qs recovered to a range of 0.83 to 1.27.

[GRAPHIC 4 OMITTED]

(1.) As dated by the National Bureau of Economic Research.

(2.) See Eugene P. Seskin and Shelly Smith, "Improved Estimates of the National Income and Product Accounts: Results of the 2009 Comprehensive Revision," SURVEY OF CURRENT BUSINESS 89 (September 2009): 15-35 and Nicole M. Mayerhauser and Erich H. Strassner, "Preview of the Comprehensive Revision of the Annual Industry Accounts," SURVEY 90 (March 2010): 21-34. The corporate data are consistent with the 2009 comprehensive NIPA revision, not the recently released 2010 annual NIPA revision.

(3.) The estimates of corporate profits and net interest are based on tabulations of "company" data rather than "establishment" data. As a result, net operating surplus of nonfinancial corporations includes the income earned by the corporation's financial services-producing establishments, and it excludes the income earned by the nonfinancial establishments of financial corporations.

(4.) Proprietors' income reflects both the return accruing to capital and the return to proprietors' and partners' labor, but these returns are not identified in the data.

(5.) The subset of ICT-producing industries consists of computer and electronic products; publishing industries (includes software); information and data processing services; and computer design and related services. Computer and electronic products are included in the manufacturing group; the other ICT-producing industries are included in the "other" nonfinancial industries group.

(6.) Outstanding corporate bonds is a gross estimate; it is not net of financial assets and debt held by nonfinancial corporations.

(7.) The market value of outstanding bonds is estimated using a procedure developed by James Tobin and Dan Sommers. Briefly, the process begins with published book values of bonds outstanding and the assumption that a bond matures in 10 years and carries a coupon rate equal to the Baa rate that prevailed in the year the bond was issued. The value of land is estimated as the difference between the value of real estate and the value of structures and of equipment and software. Net liquid assets are estimated as financial assets less liabilities other than municipal securities, corporate bonds, and mortgages. The data are from the Board of Governors of the Federal Reserve System, "Flow of Funds Accounts of the United States", statistical release Z.1 and "Selected Interest Rates," statistical release H.15 (Washington, DC: Board of Governors).

The data are available at www.federalreserve.gov/releases/Z1and www.federalreserve.gov/releases/h15.

Table 1. Net Operating Surplus and Produced Assets of Domestic
Nonfinancial Corporations and Nonfinancial Industries, 1998-2009
[Billions of dollars]

                            Nonfinancial Industries

        Nonfinancial
        corporations
                        Total        Mining,         Manu-
                                  utilities, and   facturing
                                   construction

Net operating surplus (before tax)

1998          725.7    1,305.2            153.9       313.7
1999          745.1    1,367.5            173.1       311.8
2000          708.2    1,320.1            197.9       298.8
2001          626.7    1,310.4            204.5       248.7
2002          647.1    1,395.6            181.6       272.3
2003          699.2    1,492.3            215.9       269.5
2004          877.5    1,756.4            257.0       373.7
2005        1,025.1    1,900.9            279.1       432.9
2006        1,163.7    2,017.5            303.7       482.7
2007        1,143.7    2,126.6            291.3       508.1
2008        1,024.1    2,076.4            302.1       468.2
2009          985.5        ...              ...         ...

Produced assets, average of yearend values

1998        7,341.4    8,968.6          1,613.5     2,028.6
1999        7,736.0    9,438.4          1,658.6     2,111.9
2000        8,235.7    10,036.4         1,736.4     2,200.7
2001        8,676.5    10,574.7         1,859.1     2,253.4
2002        8,988.6    10,973.8         1,989.1     2,275.2
2003        9,278.7    11,360.3         2,096.4     2,290.4
2004        9,793.2    12,019.3         2,267.4     2,350.2
2005       10,609.2    13,030.7         2,565.9     2,474.8
2006       11,482.8    14,101.2         2,884.9     2,610.7
2007       12,253.5    15,044.8         3,141.4     2,745.7
2008       12,979.2    15,912.0         3,435.8     2,858.7
2009       13,304.4        ...              ...         ...

                 Nonfinancial Industries

        Wholesale        Other          Addendum:
        and retail   industries (1)   ICT-producing
          trade                       industries (2)

Net operating surplus (before tax)

1998        213.2            624.4             47.1
1999        215.2            667.4             32.1
2000        219.4            604.0            -28.2
2001        215.2            642.1            -45.3
2002        221.8            719.9             33.2
2003        237.8            769.1             55.5
2004        248.6            877.1             98.9
2005        260.9            928.0            118.3
2006        273.5            957.7            115.9
2007        287.6          1,039.6            105.2
2008        262.0          1,044.1            105.0
2009          ...              ...              ...

Produced assets, average of yearend values

1998      1,498.4          3,828.1            344.0
1999      1,591.1          4,076.8            371.2
2000      1,698.8          4,400.6            413.4
2001      1,760.8          4,701.5            448.0
2002      1,802.9          4,906.7            455.9
2003      1,877.3          5,096.3            453.6
2004      2,007.0          5,394.8            464.1
2005      2,179.7          5,810.3            486.0
2006      2,339.4          6,266.3            510.3
2007      2,481.4          6,676.3            530.9
2008      2,581.7          7,035.8            552.7
2009          ...              ...              ...

(1.) Consists of agriculture, forestry, fishing and hunting;
transportation and warehousing; information; rental and leasing
services and lessors of intangible assets; professional,
scientific, and technical services; administrative and waste
management services; educational services; health care and social
assistance; arts, entertainment, and recreation; accommodation and
food services; and other services, except government.

(2.) Information-communication-technology ICT -producing industries
consists of computer and electronic products; publishing industries
(includes software); information and data processing services; and
computer systems design and related services, computer and
electronic products are included in manufacturing; the other
ICT-producing industries are included in "other1 industries.

NOTE. Industrywide net operating surplus for 2009 will be available
in the fall 2010 update of the annual industry accounts.

Table 2. Rates of Return and Shares of Net Value Added for Domestic
Nonfinancial Corporations and Nonfinancial Industries, 1998-2009
[Percent]

            Nonfinancial
            corporations      Nonfinancial Industries (before tax)

            After   Before                Mining,         Manu-
             tax     tax      Total    utilities, and   facturing
                                        construction

Rates of return

1998         7.7      9.9      14.6              9.5        15.5
1999         7.4      9.6      14.5             10.4        14.8
2000         6.5      8.6      13.2             11.4        13.6
2001         5.9      7.2      12.4             11.0        11.0
2002         6.1      7.2      12.7              9.1        12.0
2003         6.1      7.5      13.1             10.3        11.8
2004         7.1      9.0      14.6             11.3        15.9
2005         7.1      9.7      14.6             10.9        17.5
2006         7.5     10.1      14.3             10.5        18.5
2007         6.9      9.3      14.1              9.3        18.5
2008         6.1      7.9      13.0              8.8        16.4
2009         5.7      7.4       ...              ...         ...

Shares of net value added

1998        13.6     17.4      22.7             29.1        26.6
1999        13.0     16.9      22.4             29.9        25.8
2000        11.5     15.1      20.4             30.9        23.9
2001        11.2     13.6      20.0             30.5        21.3
2002        11.8     13.9      20.7             27.6        23.1
2003        11.7     14.5      21.1             30.3        22.5
2004        13.3     16.9      23.1             32.8        28.6
2005        13.5     18.4      23.5             32.7        31.2
2006        14.4     19.6      23.7             32.5        34.1
2007        13.8     18.7      24.1             30.6        36.1
2008        12.9     16.9      23.1             30.8        33.4
2009        13.2     17.1       ...              ...         ...

                 Nonfinancial Industries (before tax)

            Wholesale        Other          Addendum:
            and retail   industries (1)   ICT-producing
              trade                       industries (2)

Rates of return

1998             14.2             16.3             13.7
1999             13.5             16.4              8.7
2000             12.9             13.7             -6.8
2001             12.2             13.7            -10.1
2002             12.3             14.7              7.3
2003             12.7             15.1             12.2
2004             12.4             16.3             21.3
2005             12.0             16.0             24.3
2006             11.7             15.3             22.7
2007             11.6             15.6             19.8
2008             10.1             14.8             19.0
2009              ...              ...              ...

Shares of net value added

1998             19.1             21.3             14.1
1999             18.6             21.1              8.9
2000             17.9             18.1             -7.9
2001             17.4             18.4            -14.0
2002             17.6             19.8              9.1
2003             18.1             20.1             14.5
2004             18.0             21.3             22.6
2005             17.9             21.2             24.8
2006             17.8             20.7             23.3
2007             18.7             21.0             20.8
2008             17.1             20.6             20.5
2009              ...              ...              ...

(1.) Consists of agriculture, forestry, fishing and hunting;
transportation and warehousing; information; rental and leasing
services and lessors of intangible assets; professional,
scientific, and technical services; administrative and waste
management services; educational services; health care and social
assistance; arts, entertainment, and recreation; accommodation and
food services; and other services, except government.

(2.) Information-communication-technology (ICT)-producing
industries consists of computer and electronic products; publishing
industries (includes software); information and data processing
services; and computer systems design and related services.
Computer and electronic products are included in manufacturing; the
other ICT-producing industries are included in "other" industries.

NOTE. Industrywide net operating surplus for 2009 will be available
in the fall 2010 update of the annual industry accounts.

Table 3. Q-type Ratios, 1960-2009

           Q1 (1)    Q2 (2)    Q3 (3)

1960        0.77      0.93      0.57
1961        0.90      1.07      0.71
1962        0.85      1.02      0.68
1963        0.90      1.07      0.74
1964        1.01      1.18      0.87

1965        1.08      1.25      0.94
1966        0.87      1.04      0.76
1967        1.04      1.21      0.93
1968        1.13      1.31      1.04
1969        0.86      1.04      0.78

1970        0.78      0.97      0.69
1971        0.84      1.03      0.74
1972        0.97      1.16      0.85
1973        0.68      0.86      0.56
1974        0.40      0.56      0.23

1975        0.46      0.62      0.39
1976        0.52      0.67      0.44
1977        0.41      0.57      0.34
1978        0.38      0.53      0.32
1979        0.40      0.53      0.33

1980        0.46      0.58      0.39
1981        0.37      0.48      0.30
1982        0.38      0.50      0.33
1983        0.43      0.55      0.37
1984        0.40      0.52      0.32

1985        0.46      0.60      0.41
1986        0.52      0.69      0.48
1987        0.51      0.69      0.45
1988        0.54      0.73      0.48
1989        0.63      0.82      0.59

1990        0.57      0.76      0.56
1991        0.74      0.94      0.79
1992        0.79      1.00      0.93
1993        0.85      1.06      1.00
1994        0.80      1.01      0.92

1995        1.01      1.22      1.11
1996        1.02      1.24      1.09
1997        1.24      1.48      1.25
1998        1.49      1.75      1.45
1999        1.87      2.14      1.75

2000        1.51      1.79      1.32
2001        1.25      1.55      1.12
2002        0.91      1.22      0.79
2003        1.17      1.48      1.02
2004        1.23      1.54      1.06

2005        1.20      1.48      0.85
2006        1.27      1.55      0.87
2007        1.29      1.58      0.90
2008        0.77      1.06      0.56
2009        0.96      1.27      0.83

(1.) Q1 is the market value of outstanding equity divided by the
net stock of produced assets valued at current cost.

(2.) Q2 is the market value of outstanding equity plus book value
of outstanding corporate bonds divided by the net stock of produced
assets valued at current cost.

(3.) Q3 is the market value of outstanding equity plus book value
of outstanding corporate bonds plus net liquid assets divided by
the net stock of produced assets valued at current cost.