Reviewed by Erika Rasure
Fact checked by Vikki Velasquez

Some characteristics of a “good” company may include competitive advantage, above-average management, and market leadership. However, investors commonly look to financial indicators such as stable earnings, return on equity (ROE), and a company’s relative value compared with those of other companies to determine a firm’s potential.

Key Takeaways

• Earnings reports help investors the financial success of a company.
• Earnings may be measured with three metrics: growth, stability, and quality.
• Investors can use Return on Equity to estimate a stock’s growth rate and the growth rate of its dividends. 

Company Earnings

Earnings are essential for a stock to be considered a good investment. Without stable earnings, it isn’t easy to evaluate the financial success of company A versus company B, and what a company is worth beyond its book value. Earnings may be measured with three metrics: growth, stability, and quality.

Important

An earnings report is how publicly traded companies report financial results for a specific period. Public companies are required to file a 10-Q, quarterly report, and an annual report, or 10-K, with the Securities and Exchange Commission (SEC).

Earnings Growth

Earnings growth is shown as a percentage, in periods like year-over-year, quarter-over-quarter, and month-over-month. Growth means that current reported earnings should exceed the previously reported earnings. This metric establishes a pattern that can be charted and confirms a company’s historic ability to increase earnings. 

The relative relationship of the growth rate matters. For example, if a company’s long-term earnings growth rate is 5% and the overall market averages 7%, the company’s number is not impressive. However, an earnings growth rate of 7% when the market averages 5% means the company is growing faster than the market. The company should also be compared to its industry and sector peers.

Earnings Stability

Earnings stability measures how consistently earnings have been generated over time. Stable earnings growth typically occurs in industries where growth has a predictable pattern.

Earnings can grow at a rate similar to revenue growth; this is usually referred to as top-line growth. Earnings can also grow because a company is cutting expenses to add to the bottom line. Investors need to verify where the stability is coming from when comparing one company to another. 

Earnings Quality

Quality of earnings evaluation is usually left to a professional analyst, but the casual analyst can take a few steps to determine the quality of a company’s earnings. For example, if a company is increasing its earnings but has declining revenues and increasing costs, investors should research if growth is an accounting anomaly or long-lasting. 

Return on Equity

Return on equity (ROE) measures the ability of a company’s management to turn a profit on the money that its shareholders have entrusted it with. In the absence of any earnings, ROE would be negative. ROE is calculated as:

ROE = Net Income / Shareholders’ Equity

Return on equity (ROE) is a snapshot of a company’s valuation. Like earnings growth, ROE can be compared to the overall market and peer groups in the sector and industry. To this point, it is also important to examine the company’s historical ROE to evaluate its consistency.

Investors can use ROE to estimate a stock’s growth rate and the growth rate of its dividends. These two calculations make an easier comparison between similar companies. To estimate a company’s future growth rate, investors multiply the ROE by the company’s retention ratio. The retention ratio is the percentage of net income that is retained or reinvested by the company to fund future growth.

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Researching Company Data

The world of stock picking has evolved. Historically, stock analysts and brokerage firms held all of the data for investors. In 2024, only 9% of American investors surveyed used a human financial advisor to manage their investments, according to a study by ComparisonAdviser.

Since the majority of online information is free, the debate is whether to use free information or subscribe to a premium service. A rule of thumb is, “You get what you pay for.” A free site commonly provides raw data across company sectors. However, a financial advisor might be a better source to “scrub” the data or point out the accounting anomalies, enabling a clearer comparison.

Why Is Historical Earnings and ROE Data Important for Investors?

When investors see consistent earnings and ROE data, they validate that a company has established a pattern that it can consistently deliver to shareholders.

What Comparisons Should Investors Make When Evaluating a Company’s Financial Data?

None of the metrics used to value a company should stand alone. Investors should not overlook relative comparisons when evaluating whether a company is a good investment. This means comparing financial data with a company’s competitors within its sector and with the overall market.

What Does a High Return on Equity Mean?

ROE measures a company’s profitability and how efficiently it generates profits. The higher the ROE, the more efficient a company’s management is at generating income and growth from its equity financing.

The Bottom Line

Stable earnings growth is important, but its consistency and quality need to be evaluated to establish a pattern. ROE is one of the most basic valuation tools in an analyst’s arsenal but should only be considered the first step in evaluating a company’s ability to return a profit on shareholder’s equity.

To assess a company’s financial health, you have to understand its cash flow statement. It reveals how cash moves through a business, including operations, investments, and financing activities. The cash flow statement highlights liquidity, showing whether a company can generate enough cash to sustain itself, invest in growth and meet its financial obligations.

Whether you’re an investor, business owner, or analyst, learning how to prepare, read, and analyze a cash flow statement will help you identify trends, spot red flags, and make informed financial decisions with confidence.

Key Takeaways

• Cash flow statements are essential to understanding a company’s financial health.
• They consist of three main sections: operating, investing, and financing activities.
• There are two methods for preparing cash flow statements: direct and indirect.
• Analyzing cash flow statements helps identify financial trends and potential problems.

Understanding Cash Flow Statements

The cash flow statement is a part of a company’s financial statement that tracks its actual cash movements, providing a clear picture of liquidity and its financial lifeblood. Unlike the income statement, which records revenues and expenses based on accrual accounting, the cash flow statement focuses on actual cash inflows and outflows, helping stakeholders assess a company’s ability to sustain operations, invest in growth, and manage obligations.

It complements the balance sheet by explaining changes in cash balances and reconciling non-cash transactions from the income statement to reveal how much profit actually converts into cash. By analyzing these activities, investors can identify trends, detect potential cash flow issues, and make informed financial decisions.

Components of a Cash Flow Statement

The cash flow statement has three main sections: operating activities, investing activities and financing activities. Each segment provides a detailed breakdown of how cash is generated and used within a company over the stated period.

Operating Activities

This section of the cash flow statement shows how cash flows from a company’s core business operations, and whether the company can sustain itself without external financing. Cash inflows come from revenue, interest, and dividends. Cash outflows include payments to suppliers. employee wages, rent, utilities, and taxes.

Positive operating cash flow means a business is generating enough cash to cover expenses, whereas negative cash flow may signal inefficiencies in working capital.

Investing Activities

The investing activities section of the cash flow statement tracks cash movements related to long-term investments that affect a company’s growth. In this section, cash inflows come from selling assets, divesting subsidiaries, or collecting payments on loans. Cash outflows include capital expenditures (capex), investments in securities, and business acquisitions.

High capex can indicate expansion, but excessive spending without strong operating cash flow may strain liquidity. Conversely, frequent asset sales to generate cash might warn of financial distress.

Financing Activities

This segment shows how a company raises and repays capital through debt and equity financing. In this segment, cash inflows come from issuing stock or borrowing, while cash outflows include loan repayments, dividend payments, and stock buybacks. Raising cash through financing can support expansion, but excessive debt without revenue growth may pose risks. On the other hand, consistent dividends and stock buybacks signal financial strength and a commitment to shareholder value.

Preparing a Cash Flow Statement

Creating a cash flow statement involves gathering relevant financial data, choosing a preparing method, and categorizing cash flows into operating, investing and financing activities. The general steps are as follows:

• Step 1. Collect financial data: Collect the necessary data. This includes net income and non-cash expenses from the income statement, changes in assets and liabilities from the balance sheet, and bank statements to track the movement of cash.
• Step 2. Choose a preparation method: There are two methods to prepare a cash flow statement—direct and indirect.
• Step 3. Calculate cash flow from operating activities: If using the indirect method, begin with net income, add back non-cash expenses, and adjust for changes to working capital. If using the direction method, record actual cash inflows and outflows from customers, suppliers, and operating expenses.
• Step 4. Calculate cash flow from investing activities: Next, identify any cash spent on capex from long-term assets. Additionally, record cash inflows from asset sales, divestitures, or loan collections from outflows for acquisitions or new investments.
• Step 5. Calculate cash flow from financing activities: Include cash inflows from issuing stocks or borrowing funds. Deduct cash outflows from debt repayments, dividend distributions, and stock buybacks.
• Step 6. Reconcile and validate the cash flow statement: Add operating, investing, and financing cash flows to determine net change in cash. Ensure that the ending cash balance matches the balance sheet’s cash account.
• Step 7. Review and analyze: Look for negative cash flow trends that may indicate financial distress. Assess if operating cash flow is sufficient to cover investments and financing obligations. Identify unusual or inconsistent cash movements that may require further investigation.

Direct and Indirect Method

As mentioned previously there are two ways to build a cash flow statement: the direct method and the indirect method. Both methods yield the same net cash flow but they differ in presentation and the information required.

The direct method presents actual cash receipts and payments from operating activities. Instead of starting with net income, it lists cash inflows and outflows to core business operations. Alternatively, the indirect method starts with net income from the income statement and adjusts it for non-cash items and changes in working capital to arrive at cash flow from operations.

Direct Method

• Approach: Lists actual cash transactions from operating activities

• Transparency: Provides clearer visibility of cash movements

• Use of Accrual Accounting Adjustments: Not required

• Ease of Preparation: More complex, requires detailed cash tracking

• Regulatory Preference: Preferred under International Financial Reporting Standards (IFRS) but rarely used

• When Generally Used: Cash-heavy industries and when IFRS compliance is required

Indirect Method

• Approach: Starts with net income and adjusts for non-cash items

• Transparency: Less transparent but easier to prepare

• Use of Accrual Accounting Adjustments: Required

• Ease of Preparation: Easier, uses existing financial statements

• Regulatory Preference: Accepted by IFRS and GAAP, widely used by companies

• When Generally Used: Used by most companies, especially large corporations as it aligns with accrual-based financial reporting

Analyzing a Cash Flow Statement

By analyzing a cash flow statement, firstly with operating cash flow, investors can assess whether a company is generating enough cash from its core business, with positive operating cash flow indicating financial strength and negative signaling potential distress.

Additionally, investing cash flow shows how a company allocates funds for growth. High capex often indicates expansion, while frequent asset sales may indicate liquidity concerns. Moreover, financing cash flow reveals how a company raises and repays capital, with excessive debt issuance posing risks but steady dividend payments suggesting financial stability.

A strong company typically has positive operating cash flow, strategic investments, and balanced financing activities. On the other hand, cash burn, heavy reliance on debt, or frequent asset sales could indicate trouble.

Common Indicators and Red Flags

Strong indicators of financial stability include:

• Consistently positive operating cash flow
• Strategic capex
• Balanced financing activities, such as debt repayments and shareholder returns

Red flags include:

• Declining or negative operating cash flow
• Excessive reliance on external financing
• Frequent asset sales for liquidity
• High cash burn rate

Generally, a company with strong free cash flow and sustainable debt management is in good financial standing, while persistent negative trends in cash flow indicate distress.

Example of a Cash Flow Statement

The image above shows the cash flow statement for company XYZ. The analysis of cash flow activities is as follows:

Operating Activities

Net Earnings = $2,000,000

Depreciation = $10,000

Change in Inventory = -$30,000

Changes in Working Capital = Decrease in Accounts Receivable + Increase in Accounts Payable + Increase in Taxes Payable = $15,000 + $15,000 + $2,000 = $32,000

Net Cash Flow from Operating Activities = $2,000,000 + $10,000 + $32,000 – $30,000 = $2,012,000

Investing Activities

Proceeds from Equipment Purchase = -$500,000

Financing Activities

Capital Raising: Notes Payable = $10,000

Net Cash Flow =  Net Cash Flow from Operating Activities + Net Cash Flow from Investing Activities + Net Cash Flow from Financing Activities
= $2,012,000 – $500,000 + $10,000 = $1,522,000

Therefore, the net cash flow for the fiscal year in this example was $1,522,000.

The Bottom Line

Altogether, a well prepared cash flow statement can greatly assist in analyzing a company’s financial health, ensuring that cash is being managed effectively, and identifying potential risks or opportunities. By scrutinizing the operating, investing, and financing cash flows, businesses can make informed decisions, investors can assess sustainability, and analysts can detect trends that might affect long-term performance.

What Is Group Term Life (GTL) Insurance on a Paycheck?

Group term life insurance (GTL), which pays a benefit to your beneficiaries if you die, is listed on your paystub to show how much is deducted to pay for your coverage. While you can buy individual term life insurance, group term life insurance—usually a benefit offered to employees of a company—can be more affordable than individual coverage. If you elect this benefit, you’ll usually see the group term life coverage listed on your paycheck along with your other benefits.

Key Takeaways

• Group term life insurance is an affordable way to make sure your loved ones are financially protected if you die.
• As shown on your paycheck, group term premiums are usually low or fully covered by your employer. However, GTL coverage amounts may not be enough for your family’s needs.
• Group term life insurance can supplement your individual term life insurance policy or other employer-sponsored benefits without necessarily creating an additional financial burden.

How Group Term Life Insurance (GTL) Works

Group term life insurance protects your loved ones by paying them a death benefit if you die while your coverage is active. Many employers offer group term life insurance coverage as a benefit to their employees.

Because employer-sponsored group term life insurance is usually offered to all employees of the company, it’s typically more affordable than buying term life insurance as an individual, although it may have lower coverage amounts as well. You also won’t need to undergo a medical exam, as you usually do for individual term life insurance.

If you elect group term life coverage, you’ll see it listed on your paystub or other summary of benefits and deductions from your employer, along with the amount you pay each month in premiums (if any). Sometimes, the description is shortened to “GTL,” but it may be written out in full or noted in some other shorthand way, such as “life deduction.”

Your employer—and the benefits provider it chooses—will dictate the terms of your life insurance coverage. Group policies offer either a flat-rate benefit amount or one that is a multiple of your salary, albeit with a maximum coverage cap. Typical GTL coverage ranges from $50,000 to $500,000. 

Can I Convert My Group Term Life Insurance to an Individual Policy?

Your group life insurance coverage ends when the policy term ends or you leave your job. Group term policies are not portable: When you leave your employer, you’ll lose your coverage, However, you may have the option to convert your policy into an individual policy as long as you apply with the insurer within 31 days.

Note that the type of life insurance policy you can convert your group term policy into may differ from insurer to insurer. If you’re only allowed to convert to a whole life insurance policy, it will probably be more expensive than taking out a new individual term life policy.

How Is Group Term Life Insurance Taxed?

For group term life insurance coverage under $50,000, there are no immediate tax implications. Per your agreement with your employer, you’ll have your premiums deducted from your paycheck if you’re responsible for any costs outside of what your employer pays, and that amount won’t be part of your taxable income.

If your coverage is higher than $50,000, a specific amount determined by the IRS must be figured as part of your wages; this amount is taxable. The IRS assigns a monthly cost for every $1,000 of coverage in excess of $50,000, and the cost increases with successive age brackets.

Here’s how it breaks down.

Monthly Cost Per $1,000 of Group Term Life Coverage, Per IRS

Age	Cost
Under 25	$0.05
25 through 29	$0.06
30 through 34	$0.08
35 through 39	$0.09
40 through 44	$0.10
45 through 49	$0.15
50 through 54	$0.23
55 through 59	$0.43
60 through 64	$0.66
65 through 69	$1.27
70 and older	$2.06

Now, take the amount of policy coverage in excess of $50,000, divide it by 1,000 (because the cost is only calculated per $1,000 of excess), multiply it by the IRS’ cost for your age bracket, then multiply it by the number of months for which you’re receiving coverage (for simplicity’s sake, let’s say it’s a full year). That means if you’re 42 years old and receive $250,000 of group term life insurance coverage, your employer will need to include $240 ($0.10 x 200 x 12) minus whatever you paid in premiums on your W-2 as taxable income.

How Do I Choose the Right Amount of Group Term Life Insurance for My Needs?

Everyone’s needs are different. To estimate how much life insurance coverage you need, add up your debts and expenses (including some that may not have been incurred yet, such as college tuition for any children you may have). Then, compare those costs to the number of years you expect your income would be needed to help pay them. That’s likely the baseline level of coverage you need.

Advantages and Disadvantages of Group Term Life Insurance

The life insurance death benefit can help your family cover expensive bills if you’re no longer around to support them, including, but not limited to, mortgage, rent, medical expenses, and college tuition. That makes group term life insurance an attractive option if you’re not ready to pay for an individual term policy or if you don’t think you’d qualify.

Advantages of Group Term Life Insurance

• Group term life insurance is affordable, with rates as low as five cents per $1,000 of coverage. It may even be free for you if your employer covers the full cost.
• GTL is typically “guaranteed issue,” which means everyone who applies is approved. Pre-existing conditions won’t preclude you from receiving coverage or result in high premiums.
• Group term life insurance can complement other employer-sponsored benefits (such as health insurance and disability insurance) to maximize your financial protection.
• You can have both group term life insurance and individual life insurance policies.

Disadvantages of Group Term Life Insurance

• Group term life insurance tends to have lower coverage amounts, so it may not provide the right amount of financial protection you need.
• Group term policies aren’t portable, so when you leave your job, you may need to convert the coverage to a whole life insurance policy, which is typically more expensive. Plus, not all group term policies even allow conversion.
• Some group term policies reduce the benefit as you age, potentially introducing confusion as you try to figure out how much coverage you have.
• Some group term policies will increase your premium as you age, usually in five-year age groupings.

The Bottom Line

Employer-sponsored group term life insurance provides affordable coverage for employees and their families. Its lower costs, guaranteed qualification, and automatic payroll deductions complement other employee benefits, such as health insurance, to provide solid financial protection for your loved ones. However, GTL has drawbacks, including limited coverage amounts and a lack of portability if you leave the company. While it serves as a good basic safety net, you may need additional coverage to fully meet your dependents’ long-term financial needs.

Fact checked by Ariel Courage
Reviewed by Erika Rasure

A recession is a significant, persistent, and widespread contraction in economic activity. Since the Great Depression, the United States has suffered 14 official recessions. Here, we break down each one.

Key Takeaways

• A recession is an economic downturn that typically lasts for more than a few months.
• Recessions in the United States have become shorter and less frequent in recent decades.
• The COVID-19 recession was the shortest on record, while the Great Recession of 2007-2009 was the deepest since the downturn in 1937-1938.

What’s a Recession?

Recessions are sometimes defined as two consecutive quarters of decline in real gross domestic product (GDP), which measures the combined value of all the goods and services produced in an economy.

In the U.S., the National Bureau of Economic Research (NBER) dates recessions based on indicators including GDP, payroll employment, personal income and spending, industrial production, and retail sales.

Important

Recessions have grown increasingly infrequent over the past four decades.

Surveying Past U.S. Recessions

Let’s take a look at all of the official U.S. recessions since the Great Depression, focusing on common measurements of their severity as well as causes.

• Duration: How long did the recession last, according to NBER?
• GDP Decline: How much did economic activity contract from its prior peak?
• Peak Unemployment Rate: What was the maximum proportion of the workforce left jobless?
• Reasons and Causes: What unique circumstances contributed to the recession?

The Own Goal Recession: May 1937–June 1938

• Duration: 13 months
• GDP Decline: 10%
• Peak Unemployment Rate: 20%
• Reasons and Causes: Expansionary monetary and fiscal policies had secured a recovery from the Great Depression after 1933, albeit an uneven and incomplete one. In 1936-1937 policymakers changed course, more preoccupied with cutting budget deficits and heading off inflation than with the dangers of a depressive relapse. Following a tax increase in 1935 and Social Security payroll deductions starting in 1937, the budget deficit shrank from 5.4% of GDP in 1936 to 0.1% of GDP by 1938. Meanwhile, the Federal Reserve in 1936 doubled the reserve requirement ratios for banks, thus curbing lending with the stated aim of preventing “an injurious credit expansion.” Perhaps most damaging of all, the U.S. Treasury began the same year to sterilize gold inflows, ending brisk money supply growth that had supported the expansion. Industrial production began falling in September. It would decline 32% in the course of the recession. The stock market crashed in October. The recession ended after policymakers rolled back the increase in reserve requirements and gold sterilization as well as fiscal austerity.

The V-Day Recession: February 1945–October 1945

• Duration: Eight months
• GDP Decline: 10.9%
• Peak Unemployment Rate: 3.8%
• Reasons and Causes: The 1945 recession reflected massive cuts in U.S. government spending and employment toward the end and immediately after World War II. Federal spending fell 40% in 1946 and 38% in 1947 while the private sector’s output grew rapidly. The severity of the downturn remains open to question because much of the eliminated spending represented wartime production that did not serve to increase living standards. The elimination of price controls in 1946 artificially depressed output as adjusted for inflation, while the unemployment rate remained low in part because women left the workforce in large numbers.

The Post-War Brakes Tap Recession: November 1948–October 1949

• Duration: 11 months
• GDP Decline: 1.7%
• Peak Unemployment Rate: 7.9%
• Reasons and Causes: The first phase of the post-war boom was in some ways comparable to the economic recovery from the COVID-19 pandemic. Amid a backlog of consumer demand suppressed during the war and a shortage of production capacity, the collapse of wartime price controls fueled an abrupt surge of inflation by mid-1946. The annualized inflation rate rose from 3.3% in June 1946 to 11.6% two months later and 19% at its peak in April 1947. Policymakers only responded in the second half of 1947, and when they did their efforts to tighten credit ultimately led to a relatively mild recession as consumers and producers retrenched.

The Post-Korean War Recession: July 1953–May 1954

• Duration: 10 months
• GDP Decline: 2.7%
• Peak Unemployment Rate: 5.9%
• Reasons and Causes: The wind-down of the Korean War caused government spending to decline dramatically, lowering the federal budget deficit from 1.7% of GDP in fiscal 1953 to 0.3% a year later. Meanwhile, the Federal Reserve tightened monetary policy in 1953.

The Investment Bust Recession: August 1957–April 1958

• Duration: Eight months
• GDP Decline: 3.7%
• Peak Unemployment Rate: 7.4%
• Reasons and Causes: The end of the Korean War unleashed a global investment boom marked by a surge in exports of U.S. capital goods. The Fed responded by tightening monetary policy as the inflation rate rose from 0.4% in March 1956 to 3.7% a year later. Fiscal policy focused on limiting budget deficits produced a surplus of 0.7% of GDP in 1957. The 1957 Asian Flu pandemic killed 70,000 to 100,000 Americans in 1957, and industrial production slumped late that year and early in 1958. The dramatic drop in domestic demand and evolving consumer expectations led to the failure of the Ford Edsel, the beginning of the end for Detroit’s auto industry dominance. The sharp worldwide recession contributed to a foreign trade deficit. The recession ended after policymakers eased fiscal and monetary constraints on growth.

The “Rolling Adjustment” Recession: April 1960–February 1961

• Duration: 10 months
• GDP Decline: 1.6%
• Peak Unemployment Rate: 6.9%
• Reasons and Causes: This relatively mild recession was named for the so-called “rolling adjustment” in U.S. industrial sectors tied to consumers’ diminished demand for domestic autos amid growing competition from inexpensive imports. Like most other recessions, it was preceded by higher interest rates, with the Fed increasing the federal funds rate from 1.75% in mid-1958 to 4% by the end of 1959. Fiscal policy also tightened at the end of President Dwight Eisenhower’s second term, from a deficit of 2.6% of GDP in 1959 to a surplus of 0.1% a year later.

The Guns and Butter Recession: December 1969–November 1970

• Duration: 11 months
• GDP Decline: 0.6%
• Peak Unemployment Rate: 5.9%
• Reasons and Causes: Military spending increased in the late 1960s amid growing U.S. involvement in the Vietnam War and alongside high expenditures on domestic policy initiatives. As a result, the federal budget deficit rose from 1.1% of GDP in 1967 to 2.9% in 1968, while inflation increased from 3.1% in 1967 to 4.3% a year later and 5.3% by 1970. The Federal Reserve increased the federal funds rate from 5% in March 1968 to more than 9% by August 1969. By early 1971, the Fed had lowered the federal funds rate back below 4%, aiding the recovery.

The Oil Embargo Recession: November 1973–March 1975

• Duration: 16 months
• GDP decline: 3%
• Peak Unemployment Rate: 8.6%
• Reasons and causes: This long, deep recession began following the start of the Arab Oil Embargo, which would quadruple crude prices. That tipped the balance for an economy struggling with the devaluation of the dollar amid high U.S. trade and budget deficits and slipping domestic crude output. The collapse of the Bretton Woods Agreement fixing currency exchange rates contributed to a rise in U.S. inflation from 2.4% in August 1972 to 7.4% a year later, causing the Fed to double the federal funds rate to 10% between late 1972 and mid-1973. After increasing the federal funds rate to 13% in the first half of 1974, the Fed cut it to 5.25% in under a year. Inflation and unemployment remained elevated after the recession ended, ushering in stagflation. Unemployment reached 9% in May of 1975, after the declared end of the recession.

The Iran and Volcker Recession, Part 1: January 1980–July 1980

• Duration: Six months
• GDP Decline: 2.2%
• Peak Unemployment Rate: 7.8%
• Reasons and Causes: Accommodative monetary policy aimed at alleviating rising unemployment pushed U.S. inflation to 7% by early 1979, just before the Iranian Revolution caused oil prices to double. The Federal Reserve was already raising rates when Paul Volcker was named Fed chair in August 1979, and the rate went from 10.5% at the time of his appointment to 17.5% by April 1980. This short recession formally ended as the Fed dropped the fed funds rate back down to 9.5% by August of 1980, but inflation stayed high and the Volcker Fed wasn’t done.

Part 2 of Double-Dip Recession: July 1981–November 1982

• Duration: 16 months
• GDP Decline: 2.9%
• Peak Unemployment Rate: 10.8%
• Reasons and Causes: By the fourth quarter of 1980 inflation was up to 11.1%, prompting the Federal Reserve to raise the fed funds rate to 19% by July 1981. As the downturn worsened and joblessness climbed, Volcker resisted repeated demands in Congress to change course. By October 1982 inflation had declined to 5%, while unemployment would remain above 10% until mid-1983. Most economists today accept Volcker’s arguments at the time that failure to control inflation and restore the Fed’s credibility would have led to continued economic underperformance.

The Gulf War Recession: July 1990–March 1991

• Duration: Eight months
• GDP Decline: 1.5%
• Peak Unemployment Rate: 6.8%
• Reasons and Causes: This relatively mild recession began a month before Iraq invaded Kuwait, and the resulting oil price shock may have contributed to a frustratingly lackluster recovery. The Fed had raised the federal funds rate from 6.5% in February 1988 to 9.75% in May 1989 in an effort to contain inflation, which rose from 2.2% in 1986 to 3.9% for 1990.

The Dot-Bomb Recession: March 2001–November 2001

• Duration: Eight months
• GDP Decline: 0.3%
• Peak Unemployment Rate: 5.5%
• Reasons and Causes: The collapse of the dot-com bubble contributed to one of the mildest recessions on record following what was then the longest economic expansion in U.S. history. The Fed raised the fed funds rate from 4.75% in early 1999 to 6.5% by July 2000. The September 11 attacks and the associated economic disruptions may have hastened the recession’s end by encouraging the Fed to keep cutting the fed funds rate. The benchmark rate reached a low of 1% by mid-2003.

The Great Recession: December 2007–June 2009

• Duration: Eighteen months
• GDP Decline: 4.3%
• Peak Unemployment Rate: 9.5%
• Reasons and Causes: The nationwide downturn in U.S. housing prices triggered a global financial crisis, a bear market in stocks that had the S&P 500 down 57% at the lows, and the worst economic downturn since the recession of 1937-38. Global investment flows into the U.S. had kept market rates low, likely encouraging unscrupulous mortgage underwriting and mortgage-backed securities marketing practices. Oil prices spiked to record highs by mid-2008 and then crashed, depressing the U.S. oil industry. Dropping oil and commodity prices led to deflation and strained the U.S. economy.

The COVID-19 Recession: February 2020–April 2020

• Duration: Two months
• Peak Unemployment Rate: 14.7%
• Reasons and Causes: The COVID-19 pandemic spread to the U.S. in early 2020, and the resulting travel and work restrictions caused employment to plummet, triggering an unusually short but sharp recession. The unemployment rate climbed from 3.5% in February 2020 to 14.7% in April 2020 but was back below 4% by the end of 2021, capped by $5 trillion in pandemic relief spending. In addition, quantitative easing by the Federal Reserve expanded its balance sheet from $4.1 trillion in February 2020 to nearly $9 trillion by the end of 2021, complementing a federal funds rate that remained near zero until March 2022.

What Is the Average Length of a Recession?

The U.S. has experienced 34 recessions since 1857 according to the NBER, varying in length from two months (February to April 2020) to more than five years (October 1873 to March 1879). The average recession has lasted 17 months, while the six recessions since 1980 have lasted less than 10 months on average.

Which Stocks Tend Fare Better During a Recession?

Companies in the consumer staples, health care, and utilities sectors, which see relatively small fluctuations in demand for economic reasons, tend to fare best during recessions, and their stocks have outperformed during past downturns as a result.

Do Recessions Always Coincide With Bear Markets?

A bear market is commonly defined as a sustained drop of 20% or more from a market peak. Of the 25 bear markets since 1928, 14 have overlapped with recessions.

The Bottom Line

As the history of recessions over the past century or so suggests, they’re almost always preceded by monetary policy tightening in the form of rising interest rates. Fiscal contractions, whether they involve lower government spending, higher taxes, or both, have also played a role.

This is not to automatically deprecate such policies when they lead to a recession. In some cases, as during the 1970s, the long-run alternative to immediate economic pain may be even less palatable. In others, as with the end of World War II and the Korean War, there may be no easy way or no will to find immediate alternatives to high military spending.

That doesn’t change the fact that most modern recessions have occurred in response to some combination of rising interest rates, lower budget deficits, and higher energy prices.

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Reviewed by Charlene Rhinehart
Fact checked by Vikki Velasquez

PayPal Holdings Inc. (PYPL) is a dominant player in digital payments through its web and mobile app payment platforms. It’s maintained its strong position against a rising number of fintech startups and technology giants such as Apple Inc. (AAPL) and Alphabet Inc. (GOOG).

The company provides digital payment services to 434 million account holders worldwide as of 2024 (latest information), enabling them to send and receive money, hold balances, withdraw funds, and perform other functions.

PayPal was first developed as a money-transfer service by startup Confinity Inc. in 1999. In 2000, Confinity merged with Elon Musk’s online banking site X.com, which later changed its name to PayPal before going public in 2002.

PayPal soon after was acquired by eBay Inc. (EBAY) for a reported $1.5 billion and remained part of the company for the next 13 years until it was spun off in 2015. In 2024, PayPal’s revenue was $31.8 billion on a total payment volume of $1.68 trillion. It has a market cap of $69.24 billion, as of March 19, 2024.

PayPal has made many key acquisitions to fuel its growth. In most cases, these deals have expanded PayPal’s customer base or its service offerings.

Together, these acquisitions have helped PayPal to sharply boost its payment volume, a key metric used by investors to measure the company’s health and progress. Below, we’ll look at five significant PayPal acquisitions. A special note that PayPal does not provide revenue and profit figures by subsidiary.

Key Takeaways

• PayPal is a dominant player in the digital payment services space with 434 million users worldwide, competing with the likes of Apple and Google.
• Since its founding, PayPal has made strategic acquisitions, such as iZettle, Xoom, and Honey, to grow its customer base and expand its services.
• PayPal continues to witness growth in revenue and users, indicating that its acquisitions have assisted in cementing the company as an important global payment service.

Honey Science Corp.

• Type of business: Online coupons and discounting
• Acquisition price: Approximately $4 billion
• Date it was purchased: Nov. 20, 2019

Honey is an online coupon and discounting company that provides a browser extension app that automatically applies coupons on e-commerce sites. Founded in 2012, Honey had more than 17 million members and provided more than $1 billion in savings to members since its launch when it was acquired in 2019.

At the time, the company had just expanded to offer a mobile shopping assistant, price-tracking tools, and other services. PayPal’s roughly $4 billion purchase of Honey was its largest acquisition ever. The acquisition fulfills a double goal: to streamline the online shopping and payment experience for PayPal customers and drive consumer engagement and sales for merchants.

iZettle

• Type of business: Payment processing
• Acquisition price: Approximately $2.2 billion
• Date it was purchased: Sept. 20, 2018

Sweden-based iZettle was founded in 2010 as a mobile credit card payment service. It also boasted the first-ever mini chip card reader. Over time, the company has grown to offer small businesses a gamut of services such as software support and financing solutions across Europe and Latin America.

iZettle is a major competitor of PayPal’s rival Square (owned by Block Inc.). PayPal acquired iZettle mainly to expand its in-store presence with small businesses to compete with Square, and to grow its presence in the European and Latin American markets.

Note

PayPal has entered the artificial intelligence space with new AI innovations focused on both merchants and consumers.

Braintree

• Type of business: Mobile payments
• Acquisition price: Approximately $800 million
• Date it was purchased: Sept. 26, 2013

PayPal parent eBay acquired Chicago-based Braintree for $800 million in cash in 2013, helping PayPal to become a global one-stop shop for merchant account services and payment processing.

Founded in 2007, Braintree has developed a payments gateway that powers and automates online payments for merchants and online businesses. The acquisition also included peer-to-peer mobile payments app Venmo, which Braintree had bought a year earlier. Braintree remained part of PayPal after its spinoff from eBay.

Xoom Corp.

• Type of business: Payment processing
• Acquisition price: Approximately $890 million
• Date it was purchased: Nov. 12, 2015

Founded in 2001, Xoom is an international payment processing company that allows users to send money, pay bills, reload phones, and accomplish other tasks for friends and family in other countries.

At the time of the deal, Xoom had more than 1.3 million active U.S. customers who used its platform to send international remittances totaling $7 billion annually. PayPal’s acquisition of Xoom helps it to expand into new markets worldwide, including building its remittances business.

Hyperwallet Systems Inc.

• Type of business: Global payouts
• Acquisition price: Approximately $400 million
• Date it was purchased: Nov. 15, 2018

Hyperwallet was founded in 2000 as a global payout company that provides small organizations with a seamless way to distribute funds to payees.

Hyperwallet’s unique platform allows companies to send and receive payments in any currency to nearly every country in the world. PayPal’s purchase of Hyperwallet represents a key move in the company’s growing efforts to streamline and enhance its e-commerce platform offerings.

PayPal Diversity & Inclusiveness Transparency

As part of our effort to improve the awareness of the importance of diversity in companies, we have highlighted the transparency of PayPal’s commitment to diversity, inclusiveness, and social responsibility. The below chart illustrates how PayPal reports the diversity of its management and workforce. This shows if PayPal discloses data about the diversity of its board of directors, C-Suite, general management, and employees overall, across a variety of markers. We have indicated that transparency with a ✔.

PayPal Diversity & Inclusiveness Reporting
	Race	Gender	Ability	Veteran Status	Sexual Orientation
Board of Directors	✔	✔
C-Suite	✔	✔
General Management	✔	✔
Employees	✔	✔	✔ (U.S. Only)	✔ (U.S. Only)	✔ (U.S. Only)

Who Are PayPal’s Biggest Competitors?

PayPal operates in the digital payments space and its biggest competitors include Stripe, Google Pay, Apple Pay, and Square. Apple Pay and Google Pay compete with PayPal in mobile payments for smartphones. Stripe and Square compete in the business payment space, such as in point-of-sale systems.

Does Elon Musk Still Own PayPal?

No, Elon Musk does not own PayPal. Musk was a co-founder in what was the predecessor to PayPal, X.com, which later became PayPal. He sold his shares when PayPal was bought by eBay in 2002 and has not been involved in the company since.

How Many Acquisitions Has PayPal Made?

PayPal has made a total of 27 acquisitions with the average acquisition amount being $1.1 billion. Its two most active acquisition years were 2018 and 2021 when it made five acquisitions in each of these years.

The Bottom Line

PayPal is a leader in digital payment services and has reached this position by expanding its services and making strategic acquisitions. The company has steadily grown its reach and capabilities from its early days as a startup, partly due to the key acquisitions.

Acquisitions like Honey, iZettle, and Braintree have helped PayPal improve the shopping experience, strengthen its presence in global markets, and improve payment processing.

Reviewed by David Kindness
Fact checked by Suzanne Kvilhaug

What Are Key Financial Ratios for Pharma?

Pharmaceutical companies have been top performers in the healthcare sector in an era of aging populations, rising healthcare costs, and the ongoing development of new and extremely profitable medicines. Investors seeking to invest in the best pharmaceutical companies are faced with a wide array of publicly traded companies from which to choose. To make informed choices, investors need to consider the key financial ratios that are most helpful in the analysis and equity evaluation of pharma firms.

Key Takeaways:

• When evaluating stock from a specific sector, some key ratios are more informative than others.
• Pharmaceutical companies are characterized by high capital expenditures, such as the amount that must be spent on R&D to create new drugs.
• Key financial ratios for pharmaceutical companies are those related to R&D costs and the company’s ability to manage high levels of debt and profitability.

Understanding Key Financial Ratios and Pharmaceutical Stocks

Pharmaceutical companies are characterized by high capital expenditures on research and development (R&D) and a long period between initial research and finally getting a product to market. Once a pharma product reaches the marketplace, the company must determine how high a price the company can charge for a drug to earn a profitable return on its investment in the shortest amount of time. Key financial ratios for pharmaceutical companies are those related to R&D costs and the company’s ability to manage high levels of debt and profitability.

Return on Research Capital Ratio

Because R&D expenses are a major cost for pharmaceutical companies, one of the key financial metrics for analyzing pharma companies is a ratio that indicates the financial return a company realizes from its R&D expenditures.

The return on research capital ratio (RORC) is a fundamental measure that reveals the gross profit that a company realizes from each dollar of R&D expenditures. The ratio is calculated by dividing the current year’s gross profit by the previous year’s total R&D expenditures.

RORC = Current Year’s Gross Profit / Previous Year’s R&D Expenditures

Examining the RORC gives investors an idea of how well the company is managing to translate the previous year’s R&D expenses into current year revenues.

Profitability Ratios

Once a pharmaceutical company successfully brings a product to market, a key element is how the company can manufacture and sell the product. Therefore, it is also helpful for investors to look at basic profitability ratios, such as operating margin and net margin.

Operating Margin = Operating Earnings / Revenue

Operating margin, the profit per dollar of sales after paying variable production costs but before interest or taxes, indicates how well the company manages costs. Net margin is the bottom-line indicator of profit realized after deducting all of a company’s expenses, including taxes and interest.

Liquidity and Debt Coverage Ratios

Because pharmaceutical companies must make large capital expenditures on R&D, they must be able to maintain adequate levels of liquidity and effectively manage their characteristically high levels of debt.

The quick ratio is a financial metric used to measure short-term liquidity. It is calculated as the sum of current assets minus inventories, divided by current liabilities. The quick ratio is a good indicator of a company’s ability to effectively cover its day-to-day operating expenses.

Quick Ratio = (Current Assets – Inventories) / Current Liabilities

The debt ratio measures a company’s leverage and indicates the proportional amount of its assets that are financed through debt. The ratio is calculated as total debt divided by total assets.

Debt Ratio = Total Debt / Total Assets

Successfully managing debt obligations is a major factor in the long-term viability and profitability of any pharmaceutical company.

Return on Equity

The return-on-equity ratio (ROE) is considered a key ratio in equity evaluation because it addresses a question of prime importance to investors: what kind of return the company is generating in relation to its equity. A company’s ROE is a valuable indicator of how effectively the organization is utilizing its equity capital and how profitable the company is for equity investors.

ROE is calculated by dividing a company’s net income by total shareholders’ equity. Although a higher ROE figure is generally a better ROE figure, investors should exercise caution when a very high ROE results from extremely high financial leverage. This is one reason why it is also important to consider a pharma company’s debt and liquidity situation.

ROE = Net Income / Shareholders’ Equity

The importance of ROE in analyzing pharmaceutical companies stems from the basic fact that pharmaceutical companies must expend massive amounts of capital to bring their products to market. Therefore, how efficiently they employ the capital that equity investors provide is indeed a key indicator of the effectiveness of the company’s management and of the company’s ultimate profitability.

What Is the Average ROE in the Pharmaceutical Industry?

The average ROE in the pharmaceutical industry in the United States is approximately 10.49%. Companies in this industry typically have high ROEs due to their high profit margins and income, although they often use debt to boost their income.

What Is the Price-to-Research Ratio (PRR)?

The price-to-research ratio compares a company’s R&D spending to its market capitalization. It’s calculated by dividing a company’s market value by its last 12 months of R&D expenditures. A lower PRR may indicate that a company is investing more in R&D, which could mean a focus on generating future profits.

What Is the Relationship Between ROE and Debit-to-Equity Ratio?

Generally speaking, companies in the pharmaceutical industry have relatively high ROE, largely thanks to their high profits and incomes. However, income can also be leveraged with debt, which can lead to high debt-to-equity ratios. For example, as of February 2025, drug manufacturer Eli Lily had an impressive ROE of 74%. That said, its debt-to-equity ratio was 2.18, indicating that it fueled its returns with a significant amount of debt.

The Bottom Line

The pharmaceutical industry is characterized by high profit margins, income, and capital expenditures. To correctly evaluate pharmaceutical companies’ performance, it’s important to look at key metrics, such as return on research capital, profitability ratios, return on equity, and liquidity and debt coverage ratios. These metrics can help you discern whether these companies are investing in R&D, using debt to fuel income, and how good they are at managing costs.

Reviewed by Somer Anderson
Fact checked by Kirsten Rohrs Schmitt

An asset bubble occurs when the price of an asset, such as stocks, bonds, real estate, or commodities, rises rapidly without the underlying fundamentals to justify the price spike. The inevitable collapse wipes out the net worth of investors and causes exposed businesses to fail, potentially beginning a cascade of debt deflation and financial panic that can spread to other parts of the economy. This can result in a period of higher unemployment and lower production that characterizes a recession.

Asset price bubbles shoulder the blame for some of the most devastating recessions in history. The stock market bubble of the 1920s, the dot-com bubble of the 1990s, and the real estate bubble of the 2000s were asset bubbles followed by sharp economic downturns.

Key Takeaways

• Asset bubbles are formed when market prices in some sectors increase over time and trade far higher than the fundamentals would suggest.
• An expansion of the supply of money and credit in an economy provides the necessary fuel for bubbles.
• Technological factors, incentives created by public policies, and the particular historical circumstances around a given bubble help to determine which asset classes and industries are the focus of a bubble.
• Market psychology and emotions like greed and herding instincts may magnify the bubble further.
• When bubbles eventually burst, they tend to leave economic pain in their wake, such as a recession or a depression.

How an Asset Bubble Can Lead to a Recession

It is normal to see prices rise and fall over time as buyers and sellers discover and move toward equilibrium in a series of successive trades over time. It is normal to see prices overshoot (and undershoot) the prices implied by the fundamentals of supply and demand as this process proceeds, as has been readily demonstrated by economists in controlled experiments and classroom exercises. 

In actual markets, prices may always be either above or below the implicit equilibrium price at any given point as the fundamentals of supply and demand change over time while the price discovery process is simultaneously in motion. However, prices tend to seek or move toward the implicit equilibrium price over time as market participants gain experience and information about market fundamentals and the past series of prices.

What makes a bubble different is that the prices for a given class of assets or goods overshoot the implied market equilibrium price, remain persistently high, and even continue to climb rather than correct toward the expected equilibrium prices. This happens because of an increase in the supply of money and credit flowing into that market, which gives buyers the ability to continue to bid prices higher and higher.

Asset Price Bubbles

In an asset price bubble, new money entering the market keeps prices rising well beyond the fundamental value of the underlying assets implied by simple supply and demand.

When a central bank or other monetary authority expands the supply of money and credit in an economy, the new units of money always enter the economy at a specific point in time and into the hands of specific market participants, and then spread out gradually as the new money changes hands in successive transactions. Over time, this causes most or all prices to adjust upward, in the familiar process of price inflation, but this does not happen instantaneously to all prices.

Early recipients of the new money are thus able to bid up prices for the assets and goods that they purchase before prices in the rest of the economy rise. This is part of the economic phenomenon known as the Cantillon Effect. When buying activity in the market is focused on a specific asset class of assets or economic goods by the circumstances of the time, then the relative prices of those assets rise compared to other goods in the economy. This is what produces an asset price bubble.

The prices of these assets no longer reflect the real conditions of supply and demand relative to all other goods in the economy. Instead, they are driven higher by the Cantillon Effect of the new money entering the economy.

When an asset price begins rising at a rate appreciably higher than the broader market, opportunistic investors and speculators jump in and bid the price up even more. This leads to further speculation and further price increases not supported by market fundamentals. The mere expectation of future price appreciation in the bubble assets drives buyers to bid prices higher. The resulting flood of investment dollars into the asset pushes the price to even more inflated levels.

The real trouble starts when the asset bubble picks up so much speed that non-investors— effectively the last recipients of the newly created money as it trickles down to their wages and business income—take notice and decide that they, too, can profit from rising prices. At this point, prices throughout the economy already have begun to rise, as the new money has spread through the economy to reach the pockets of these non-investors. Because it is now circulating throughout the economy, the new money no longer has the power to continue pushing the relative prices of the bubble assets up compared with other goods and assets.

Early recipients of the new money sell to the latecomers, realizing outsized profits. These late buyers, however, realize little or no gains as the price bubble stalls for want of new money. The price bubble is no longer sustainable without additional injections of new money (or credit) by the central bank or monetary authority.

The bubble then begins to deflate. Other prices in the economy are rising to normalize the relative prices of the bubble assets, and no new money is entering the economy to fuel more bubble price rises, both of which also damp expectations of future bubble price appreciation. Late buyers are disappointed by lackluster gains, and the speculative optimism that magnified the bubble’s rise now reverses. Bubble prices begin to fall back toward those implied by market fundamentals.

The central bank or other monetary authority may at this point try to continue inflating the bubble by injecting more new money and repeating the process described above. Alternatively, after a sustained period of monetary injections and bubble inflation, it may cut back on injecting new money to tamp down consumer price and wage inflation. Sometimes a real economic shock, such as a spike in oil prices, helps trigger a cutback in monetary injections.

When the flow of new money stops, or even slows substantially, this can cause the asset bubble to burst. This sends prices falling precipitously and wreaks havoc for latecomers to the game, most of whom lose a large percentage of their investments. The bursting of the bubble is also the final realization of the Cantillon Effect. What unfolds is not just a change in relative prices on paper during the rise of the bubble, but a large-scale transfer of real wealth and income from the latecomers to the early recipients of the newly created money who started the bubble.

Redistribution of Wealth

This redistribution of wealth and income from late investors to the early recipients of newly created money and credit who got in on the ground floor is what makes the formation and collapse of asset price bubbles very much like a pyramid or Ponzi scheme.

When this process is driven by money in its modern form of a fiat currency mostly made of fractional reserve credit created by the central bank and the banking system, then the bursting of the bubble not only induces losses to the then-current holders of the bubble assets, but can also lead to a process of debt deflation that spreads beyond those exposed directly to the bubble assets to all other debtors as well. This means that any sufficiently large bubble can crash the entire economy into a recession under the right monetary conditions.

Historical Examples of Asset Bubbles

The biggest asset bubbles in recent history have been followed by deep recessions.

While the correlation between asset bubbles and recessions is irrefutable, economists debate the strength of the cause-and-effect relationship. Many argue that other economic factors may contribute to recessions, or that each recession is unique, so general causes can’t really be identified.

Some economists even dispute the existence of bubbles at all, arguing that large real economic shocks randomly knock the economy into a recession from time to time, independent of financial factors, and that price bubbles and crashes are simply the optimal market response to changing real fundamentals.

Broader agreement exists, however, that the bursting of an asset bubble has played at least some role in each of the following economic recessions.

1920s Stock Market Bubble/Great Depression

The 1920s began with a deep but short recession that gave way to a prolonged period of economic expansion. Lavish wealth, the kind depicted in F. Scott Fitzgerald’s The Great Gatsby, became an American mainstay during the so-called Roaring Twenties. The bubble started when the Federal Reserve eased credit requirements and lowered interest rates in the second half of 1921 through 1922, hoping to spur borrowing, increase the money supply, and stimulate the economy.

It worked, but too well. Consumers and businesses began taking on more debt than ever. By the middle of the decade, there was an additional $500 million in circulation compared with five years earlier. The Fed’s easy-money policies extended through most of the 1920s, and stock prices soared as a result of the new money flowing into the economy through the banking system.

The Roaring ’20s

The steady expansion of the supply of money and credit through the 1920s fueled a massive bubble in stock prices. Widespread adoption of the telephone and the shift from a majority-rural to a majority-urban population increased the appeal of more sophisticated savings and investment strategies such as stock ownership vs. traditionally popular savings accounts and life insurance policies.

The excess of the 1920s was fun while it lasted but far from sustainable. By 1929, cracks began to appear in the facade. The problem was that debt had fueled too much of the decade’s extravagance. The investors, the general public, and the banks eventually became skeptical that the continuous extension of new credit could go on forever, and began to cut back to protect themselves from the eventual speculative losses. Savvy investors, the ones tuned in to the idea that the good times were about to end, began profit taking. They locked in their gains, anticipating a coming market decline.

Before too long, a massive sell-off took hold. People and businesses began withdrawing their money at such a rate that the banks didn’t have the available capital to meet the requests. Debt deflation set in despite Fed attempts to reinflate. The rapidly worsening situation culminated with the crash of 1929, which led to the insolvency of several large banks due to bank runs.

The crash touched off the Great Depression, still known as the worst economic crisis in modern American history. While the official years of the Depression were from 1929 to 1939, the economy did not regain footing on a long-term basis until World War II ended in 1945.

1990s Dot-Com Bubble/Early 2000s Recession

In the year 1990, the words internet, web, and online did not even exist in the common lexicon. By 1999, they dominated the economy. The Nasdaq index, which tracks mostly tech-based stocks, hovered just above 710 in October 1990. By the turn of the century, it had soared past 6,700.

In 1995, the Fed began easing monetary policy to support the government bailout of the holders of Mexican bonds in response to the Mexican debt crisis. U.S. M2 money-supply growth quickly accelerated from less than 1% per year to more than 5% as the Fed began injecting new reserves into the banking system, peaking at over 8% by early 1999.

The new liquid credit that the Fed added to the economy began to flow into the emerging tech sector. As the Fed dropped interest rates starting in 1995, the Nasdaq began to take off, internet service provider Netscape launched its initial public offering (IPO), and the dot-com bubble began.   

Market Hype

The hype of new technologies can attract the flow of new money investment that leads to a bubble.

The internet changed the way the world lives and does business. Many robust companies launched during the dot-com bubble, such as Google, Yahoo, and Amazon. Accompanying these success stories, however, were several fly-by-night companies with no long-term vision, no innovation, and often no product at all. Because investors were swept up in the dot-com hype, these companies still attracted millions of investment dollars, with many even managing to go public without ever releasing a product to the market.

As wage and consumer price pressures mounted amid a flood of liquidity meant to combat the underwhelming effects of the Y2K bug, the Fed began cutting back money-supply growth and raising interest rates in early 2000. This pulled the rug out from under the Fed-fueled hype of the tech boom.

A Nasdaq sell-off in March 2000 marked the end of the dot-com bubble. The recession that followed was relatively shallow for the broader economy but devastating for the tech industry. The Bay Area in California, home to tech-heavy Silicon Valley, experienced a sharp rise in unemployment.

2000s Real Estate Bubble/Great Recession

Many factors coalesced to produce the 2000s real estate bubble. The biggest was monetary expansion leading to low interest rates and significantly relaxed lending standards.

The Fed dropped its target interest rate to successive historic lows from 2000 to mid-2004, and the M2 money supply grew an average of 6.5% per year. Federal housing policies under the general heading of the “ownership society” championed by then-President George W. Bush helped drive newly created credit into the housing sector, and deregulation of the financial sector allowed the multiplication of exotic new home-loan products and credit derivatives based on them.

As house-buying fever spread, lenders—particularly those in the high-risk arena known as subprime—began competing with each other on who could relax standards the most and attract the riskiest buyers. One loan product that best embodies the level of laxity reached by subprime lenders in the mid-2000s is the NINJA loan: no income, no job, or asset verification were required for approval.

For much of the 2000s, getting a mortgage was easier than getting approved to rent an apartment. As a result, demand for real estate surged. Real estate agents, builders, bankers, and mortgage brokers luxuriated in the excess, making piles of money as easily as the 1980s Wall Street “masters of the universe” portrayed in Tom Wolfe’s The Bonfire of the Vanities.

As one might expect, a bubble fueled in large part by the practice of lending hundreds of thousands of dollars to people unable to prove they had assets or even jobs was unsustainable. In certain parts of the country, such as Florida and Las Vegas, home prices began to tumble as early as 2006.

By 2008, the entire country was in full economic meltdown. Large banks, including the storied Lehman Brothers, became insolvent—a result of tying up too much money in securities backed by the aforementioned subprime mortgages. Housing prices tumbled by more than 50% in some areas. The resulting Great Recession crashed markets around the globe, put many millions out of work, and permanently reshaped the economy’s structure.

What Happens When the Market Is in a Bubble?

The clearest sign that a market is in a bubble is when assets trade for way more than what they are truly worth. A sudden surge in prices without any clear justifying factor generally suggests a bubble is underway.

What Happens When a Financial Bubble Bursts?

When the bubble bursts, prices tumble. Those who fail to sell before this happens can lose significant amounts of their invested capital, and companies may be forced to curtail spending and slash budgets. When the victims of a bubble are numerous, it can have a huge impact on the economy, sparking mass unemployment, reduced consumer spending, and debt deflation.

Asset bubbles are especially devastating for individuals and businesses who invest too late, meaning shortly before the bubble bursts. In this regard, asset price bubbles bear a similarity to Ponzi or pyramid scams.

How Do Bubbles Affect the Economy?

Bubbles affect the economy because they prompt members of the population to lose lots of money and often culminate in monetary policy being tightened. Widespread losses can create financial panic, erode spending, and trigger unmanageable debt.

The Bottom Line

The stock market bubble of the 1920s, the dot-com bubble of the 1990s, and the real estate bubble of the 2000s offer clear examples of how bullish investor sentiment can destroy economies and deepen inequality. While each of these bubbles has its own story, there are aspects that tie them together, including that they were driven by a flow of cheap money being pumped into the economy via monetary expansion and lower borrowing rates.

Eventually, policies are reversed, money dries up, and people begin realizing that assets are trading way beyond what they are truly worth. When this happens, the results can be catastrophic—for not just the participants but everyone in the economy.

Positive vs. Normative Economics: An Overview

Economics is a field that exists between scientific objectivity and subjective interpretation. Suppose a policymaker is trying to decide whether a proposed new tax is a good idea. One economist might advise, “This tax will likely increase government revenue by 10% per year,” while another says, “The government should use taxes to reduce inequality.” The first statement is factual—something that can tested. The second is an opinion rooted instead in values about what’s fair or right.

Thus, in economics, as in many other disciplines, it’s crucial to distinguish between descriptions of what is the case (“robberies are high in this city”) and what’s ethically right or should be the case (“stealing is wrong” or “robberies should be far lower”). For this reason, in the last 19th century, John Neville Keynes (the father of John Maynard Keynes) made the distinction between positive and normative economics by differentiating one as “the science of what is” vs. “the science of what ought to be.” Positive economics focuses on the former, making objective and testable economic analysis based on data; normative economics focuses on the latter, with value-based assessments and recommendations about desirable economic outcomes.

In theory, this might sound straightforward. However, it becomes more complicated in practice because economic analyses frequently mix elements of both. We dig into these complications below.

Key Takeaways

• Positive economics focuses on “what is.” This approach relies upon empirically verifiable statements about economic conditions.
• Normative economics focuses on “what should be.” This branch of economics includes value-based assertions.
• Testable positive statements help explain and predict world events, while normative statements can’t be tested by facts because they are about what ought to be the case.
• Practitioners often combine positive and normative economics in their work.

Positive Economics

Positive economics focuses on describing and explaining economic phenomena as they are. It’s supposed to be using models based on objective data. This is the part of economics that, since Adam Smith, has always aimed to be a science. Positive economic statements are specific and should be testable against evidence​.

The goal is to understand the workings of the economy without bringing in personal opinions or making moral judgments. For example, “Government-provided healthcare increases public expenditures” is a positive economic statement​: we can examine data from countries with socialized healthcare to see if public spending is indeed higher. But then, that seems to be the case definitionally. We’d want ultimately to conclude how efficient they are and what kinds of health outcomes different systems have so we can then say what kind of system we should have.

Because positive economics relies on data and observable facts, it avoids using loaded words like “should” or “ought to.” Policymakers rely on positive economics to answer questions like, “What will happen if we raise the gasoline tax?” or “How would increasing the minimum wage affect unemployment?”

The predictions made by economists tackling such questions describe likely outcomes without stating whether those outcomes would be good or bad. Instead, they help policymakers and economists understand how to achieve their goals: if a government aims to improve health outcomes, positive analysis can be used to answer fiscal and other outcomes in different healthcare systems.

Positive economics was popularized by the Nobel-prize-winning economist Milton Friedman, who argued that economics should be an objective science, free of personal bias or agenda-setting. Of course, he would become famous for long-running commentaries about policies he thought should be the case—that is, work in normative economics that he thought was grounded in his positive economics research.

Normative Economics

Normative economics focuses on values-laden perceptions of what are desirable vs. undesirable outcomes instead of analyzing factual data and cause-and-effect relationships. As such, it is often regarded as the “what ought to be” side of economics.

Normative statements reflect subjective viewpoints because they originate from individual values, cultural beliefs, and political ideals. The use of words like “should,” “ought,” “better,” and “worse” in normative economics suggests that they should be considered alongside other ethical and moral judgments.

One of the most notable proponents of normative economics is Amartya Sen, another Nobel Prize winner who has made major contributions to development economics.

Since normative economic statements reflect individual moral judgments, they can’t be validated or disproven by data analysis alone. For example, “The government should provide basic healthcare to all citizens” is a normative claim. This statement reflects a value judgment that considers universal healthcare a worthy ideal—a moral viewpoint.

Because of this, reasonable people can and often do disagree about normative economic statements even when they agree about the positive economic facts associated with them.

Positive Economics

• Positive statements require testing through observation and data analysis to determine their validity.

• Maintains value neutrality by concentrating on facts and evidence.

• Describes economic phenomena as they exist.

• Employs the scientific method.

Normative Economics

• Normative statements integrate ethical assessments and value judgments.

• Determines which policies should be implemented and defines desirable results.

• Presents recommendations that are grounded in specific goals or values.

• The same set of positive facts can lead to different normative conclusions based on individual values and priorities.

From Description to Prescription

The distinction between positive and normative economics highlights the dual nature of economics as both a science and a social discipline concerned with human welfare. While the two approaches differ fundamentally in their orientation and methodology, they are often taken as complementary rather than antagonistic. Indeed, effective economic analysis and policymaking typically involve elements of both.

Normative discussions about what the economy should aspire to depend on a factual foundation provided by positive economics. An understanding of economic systems and policy effects must precede meaningful debates about better economic policies.

Normative discussions can become detached from reality without accompanying positive economic analysis, which can result in good intentions producing harmful policy outcomes. Meanwhile, positive economics by itself often proves inadequate. Positive economic analysis at its most rigorous fails to define which policy objectives we need to prioritize or which trade-offs we should accept. Is economic growth more important than protecting the environment? Is it appropriate to support policies that create wealth at the expense of increasing social inequalities? Positive economics alone can’t answer these questions because they demand normative judgments about our values and priorities.

In addition, the way positive economics frames given sets of economic facts or has an interest in one area of the economy rather than others could mean norms are never too far away.

Important

Economists occasionally present normative conclusions as factual statements without intending to do so. Other times, economists may intentionally combine positive analysis with normative evaluation to nudge policymakers toward particular outcomes.

The Bottom Line

Both positive and normative economics are essential for analyzing and discussing contemporary economic matters. Positive economics establishes the factual basis for how the economy functions, while normative economics informs economic goals according to society’s moral ideals and priorities. 

Good policy decisions typically require both: A thorough, positive analysis combined with normative reasoning that identifies which outcomes should be pursued. 

Reviewed by Anthony Battle
Fact checked by Vikki Velasquez

Social Security is a federal program in the United States that provides taxpayers with certain benefits, including retirement and disability income.

Medicare, Medicaid, and death and survivorship benefits are also part of the Social Security program.

Social Security taxes are collected from most workers, regardless of whether they work for an employer or are self-employed. These taxes are used to fund Social Security benefits.

However, some American taxpayers may be exempt from paying Social Security taxes. Read on to learn who they are.

Key Takeaways

• People who work for certain religious groups may qualify for Social Security tax exemption if they and their groups are recognized as being officially opposed to Social Security benefits.
• Non-resident aliens may qualify for exemption based on the type of visa they have been issued.
• Current students who acquire college jobs that are contingent upon their college enrollment are eligible for a Social Security tax exemption on the income earned from those positions.
• Individuals who work for a foreign government may be exempt from Social Security taxes while working in an official capacity on official business.
• If you don’t pay Social Security taxes, you will not receive Social Security benefits.

Who Is Exempt From Social Security Taxes?

Members of Qualifying Religious Groups

Members of certain religious groups qualify for Social Security tax exemption. To claim such an exemption:

• You must waive your rights to all Social Security benefits, including hospital insurance.
• Your religious group, and you, must be officially opposed to public or private insurance plan benefits (including Social Security benefits) such as retirement, disability, and death benefits.
• You and your employer are members of such a religious group and your applications for exemption have been approved.
• Your religious group has been in existence continuously since Dec. 31, 1950.
• Your religious group can demonstrate that it has continuously made “reasonable provision” for its dependent members since Dec. 31, 1950.

Religious organizations and their members who desire exemption from Social Security taxes must apply for it by completing Form 4029.

Individuals who have qualified for Social Security benefits (even if these benefits were never utilized) will not be exempt.

Important

If you don’t pay Social Security taxes, you cannot receive Social Security benefits.

Non-Resident Aliens

Non-resident aliens (individuals who are not U.S. residents or citizens) usually pay Social Security taxes but may qualify for an exemption based on the type of visa they have been issued.

Non-residents with the following visas are exempt from paying Social Security taxes:

A visas

Foreign government employees (plus their families and household personnel) are exempt from paying taxes on the salaries they earn in their official capacities.

D visas

The crew on a ship or aircraft may be exempt if they serve on a foreign vessel and for a foreign employer, or if they serve outside the U.S.

F, J, M, and Q visas

Students, scholars, educators, trainees, researchers, and others in the U.S. temporarily are exempt from Social Security taxes on earnings if the work is allowed by the U.S. Citizenship and Immigration Services (USCIS) and it’s work that they entered the U.S. to carry out.

G visas

The employees of international organizations whose work takes place in the U.S. in their official employment capacity are exempt from paying Social Security taxes.

H visas

An H-2 non-resident who is a resident of the Philippines and who performs services in Guam is exempt from paying Social Security taxes.

So is an H-2A non-resident who comes to the U.S. temporarily to perform agricultural labor.

Certain other non-resident wages paid for specific types of work, such as ministry services and student nursing, are exempt as well.

Students With Jobs at Their Schools

A student who acquires a job at their university (or college) that’s tied to their continued enrollment is eligible for a Social Security tax exemption on the income earned from their job.

School employees who use an employee benefit to enroll at the university do not qualify.

Note

In 2025, if you do pay Social Security taxes, you only pay on income through $176,100. No tax is applied to income beyond that amount.

Foreign Government Employees

Individuals who work for a foreign government may be exempt from Social Security taxes while working on official business, if the applicable tax treaty provides for an exemption or the government meets the applicable U.S. law.

Their employees, spouses, children, and household personnel only qualify for the exemption if they are also employees of a foreign government.

In addition, an individual who works for an international organization may also qualify for the exemption from Social Security taxes, if the agreement that created the organization provides for an exemption or the organization meets the applicable U.S. law.

Why Would Someone Seek Exemption From Paying Social Security Taxes?

They might seek an exemption from the tax if they didn’t believe in the idea of Social Security (and waived their right to the benefits). Or, if they didn’t want their income reduced by an unnecessary tax, they might seek an exemption if they already had similar insurance in another country.

How Much Is the Social Security Tax?

The Social Security tax is 12.4%. Employers pay 6.2% for their employees, while the employee pays the other 6.2%. If you’re self-employed, you pay the entire 12.4% yourself and can deduct the employer’s share of 6.2% from your taxable income.

I Enrolled in College Tuition-Free Because I Work There. Am I Exempt from Social Security Taxes?

No, you must pay social security taxes because you are a “professional employee” of the college. If however, you enrolled in college, were offered a job there, and your job depended on you staying enrolled, you would be exempt from Social Security taxes.

The Bottom Line

Some individual wage-earners in the U.S. may qualify for an exemption from paying Social Security taxes.

This group of people consists of members of certain religious groups, non-resident aliens, students who have a job at the college at which they’re enrolled, and employees of foreign governments or international organizations.

Be sure to check on the requirements involved because even if you are one of those who qualifies, you may need to apply for the exemption to be recognized by the IRS as exempt.

In this episode of “The Deep Dive,” Dennis Moseley-Williams talks with host Jay Hummel about how advisors should think about the client experience today. Dennis argues that the shift to the “service versus experiences” model puts client well-being at the forefront. 

Most companies sell products and services, and the best create meaningful experiences. Dennis challenges leaders to rethink value, loyalty, and what customers truly want. 

Dennis Moseley-Williams:  An author, speaker, and experienced economy expert, Dennis teaches businesses to shift from transactions to transformation—competing on meaning, not price. He founded his company, DMW Strategic Consulting, in 2002 and resides in Ottawa, Ontario.