Figure 1010

Profit Rates Display Mean Reversion over Time

Entry into high-profit industries drives down both prices and profits. Over time, entry causes above-normal profits to regress toward normal profit rate, whereas exit allows the below-normal profits of depressed industries to rise toward the mean.

Profit Rates Display Mean Reversion over Time

Entry into high-profit industries drives down both prices and profits. Over time, entry causes above-normal profits to regress toward normal profit rate, whereas exit allows the below-normal profits of depressed industries to rise toward the mean.

factors as contributors to high rates of business profits, it is interesting to analyze the components of ROE for top-performing large firms shown in Table 10.2. Many such companies earn a ROE of 20 to 35 percent per year on a regular basis. Drug companies such as Bristol-Myers Squibb and Merck display the lofty profit margins associated with the marketing of innovative patent-protected pharmaceuticals. Other firms with special characteristics are also found among high-profit margin firms. For example, the William Wrigley Jr. Co. and Hershey Foods Corp. enjoy dominant market positions in the chewing gum and candy industries, respectively. Dow Jones & Co., publishers of The Wall Street Journal and Barron's financial weekly, produces information that is a must read for Wall Street professionals and thereby enjoys enviable brandname recognition in the financial news and reporting business.

It is interesting to note that the top-performing firms displayed in Table 10.2 exemplify wide variety in terms of industry and in terms of the relative importance of profit margins, total asset turnover, and leverage as contributors to ROE. This diversity suggests that firm-specific factors, such as superior efficiency, and industry-related factors, such as market power, both contribute to the realization of above-normal rates of return.

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