Profit Margins: When Is Greed No Longer Good?

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- In Oliver Stone's 1987 film, Wall Street, business mogul Gordon Gekko (portrayed by Michael Douglas in an Oscar-winning performance) extolled the virtues of greed:
Greed, for lack of a better word, is good. Greed is right. Greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge, has marked the upward surge of mankind and greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the U.S.A.

When Wall Street was first released, clever Gekko-wannabees quickly reduced Gekko's tirade to a three-word slogan: "Greed is good." Even the collapse of WorldCom and Enron weren't enough to drive that phrase out of popular parlance, or out of the minds of ambitious financiers. Quarter-over-quarter profits became commonly expected and executives who failed to consistently produce double-digit profit margins saw their corporations' stock prices hammered in the markets.

Now, however, as the economic downturn lingers, unemployment hovers at 9% and America's cities are jammed with Occupy Wall Street protestors, it's time to ask another question: even if greed is good, at what point does it cease to be so? When do high profit margins stop being a benefit of wise corporate stewardship and become evidence of avarice run amok?

The answer probably depends on how the profits are used. A company that generates double-digit profits can use them to grow the business, develop innovative products and create more jobs.

For example, in 1999, Intuitive Surgical ( ISRG) created and introduced a robotic-assisted minimally invasive surgery system. Intuitive Surgical reports that it has since expanded its installed base to more than 1,450 hospital sites, providing technological and procedural innovations across a range of surgical disciplines. The company has reportedly also sustained annual growth in excess of 25%. It's a good news story that has earned Intuitive Surgical on CNN Money's 2010 list of rising stars and has probably also saved a lot of lives.

But when double-digit profits get paid out in hefty executive bonuses or dividends to already wealthy investors or, worse, get hoarded against another economic downturn, the news is far less positive.

For example, despite increasingly strident news coverage some companies continue to pay tens of millions to their CEOs each year, in some cases increasing their annual compensation by magnitudes of three times or more. Perhaps it's not surprising in the banking sector -- JP Morgan Chase ( JPM), Goldman Sachs ( GS) and US Bancorp ( USB) all gave their CEOs massive raises this year.

But companies like Stanley Black & Decker ( SWK), Target ( TGT), Sunoco ( SUN), Avis Budget ( CAR), General Electric ( GE), and Motorola ( MOT), all of whom cater to the consumer market, also lavished money on their CEOs. And the big bucks don't just go to chief executives -- even in these tough times, some investors are reaping massive dividends from corporate profits.

For example, Reuter's reports that British low-cost airline easyJet enjoyed a 31.5% rise in full year profit, thanks in part to a rise in business travelers and cost cuts. But instead of expanding its business, hiring more employees or improving its services to make those business travelers more comfortable, easyJet made its first-ever dividend payment to shareholders, shelling out a whopping 195 million pounds (about $314 million).

Such hefty payments to investors and top executives might be less troubling if the money would eventually distribute itself throughout the economy. But, as economist Joseph E. Stiglitz pointed out in the May issue of Vanity Fair, the upper 1% of Americans are now raking in almost 25% of the nation's income each year, and control about 40% of the nation's wealth. At the same time, the ranks of the poorest of the poor -- defined as those living at or below 50% of the poverty level -- has increased to record levels, rising to one out of every 15 Americans. Whatever the top 1% is doing with its money, it doesn't seem interested in sharing with everyone else.

And, in the long term, that strategy is fated for disaster. Poverty is only individual misery to a point. As a 2007 General Accounting Office study recognized, poverty generates crime, disease and illiteracy which, in turn, erodes society's collective quality of life. (Incidentally, it may also put America at a disadvantage in the global marketplace, because sickly, violent and unschooled workers are less likely to compete well.) Further, an economy that only significantly rewards a handful of professions -- top business executives, financiers and, to a lesser extent, lawyers and doctors -- creates little incentive for talented youngsters to choose other career paths. Opportunities for advances in science, technology, manufacturing, education and the arts may be lost if tomorrow's workforce decides, like Gordon Gekko, that "greed is good."

But perhaps the greatest concern we should have is what life will be like for all Americans if profits continue to be hoarded by an increasingly wealthy few. Yes, the very rich may be able to shield themselves from general poverty and despair for a while and, in fact, Internal Revenue Service data show that they're already doing so. According to recent IRS data, about 93% of the very rich live in metropolitan areas, and the top 3% are highly concentrated in a handful of cities. Simultaneously, the poorest of the poor are being driven out of cities by skyrocketing rents and costs of living. Unless something changes, the wealthy may find themselves essentially imprisoned in gilded metropolitan cages of their own making.

As Stiglitz correctly observed, America has long prided itself on being a fair country, where meaningful opportunity exists for anyone who's willing to work hard. But as economic inequality grows, our collective right to take that pride is increasingly jeopardized. So maybe that's the answer. There may be times when some greed is beneficial. But when it undermines our national principles, puts our country's future at risk and threatens our quality of life, whatever else it may be, greed is no longer good.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.