Other factors contributing to high corporate margins are today's low rates of capacity utilization and high rates of unemployment.
While capacity utilization has rebounded to 77.6 in July from a low of 66.9 in June 2009, the metric is still below the long-term average of 80.6 (since 1980).
Companies are carrying excess levels of idle factory capacity, which means they can ramp up production without having to incur the costs of adding new capacity. With regard to labor costs, companies see no need to increase wages while there are still millions of workers looking for jobs.
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As a direct result of high unemployment, wage growth has not kept up with the rate of inflation over the past few years.
Another recent Journal article ("Stagnant Wages Are Crimping Economic Growth") said that "Four years into the economic recovery, U.S. workers' pay still isn't even keeping up with inflation. The average hourly pay for a non-government, non-supervisory worker, adjusted for price increases, declined to $8.77 last month from $8.85 at the end of the recession in June 2009, Labor Department data show."
So clearly these two factors, low capacity utilization and high unemployment, have kept a lid on corporate expenses over the past few years. But what about the revenue side of the equation?
Perhaps the best explanation for today's high profit margins is much more intuitive.
In an excellent recent note entitled "Baked in the Cake", John Hussman of the Hussman Funds states, "Corporate profits move tightly and inversely to the combined sum of household and government savings."
In other words, profit margins are so high right now because the government has been running record budget deficits and consumers have been saving a much smaller percentage of income in recent years.
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The debt-fueled spending of the past several years has allowed companies to "maintain revenues despite the fact that workers (and the government) are not, in aggregate, earning sufficient income to support that consumption."
If you believe, as we do, that the level of consumer and government spending is unsustainable, it makes sense to question the sustainability of corporate revenue, profits and margins as well.
P/E ratios that incorporate today's high corporate profit margins may be less useful than they have been in the past.
In our view, we cannot rely upon the sustainability of high profit margins for several years into the future. In the same research note cited above, Hussman makes a very good point with regard to investors' over-dependence on the ratio of price to forward earnings.
"It's essential to remember that stocks are not a claim on a single year of income, but are instead a claim on a very long-term stream of future cash flows that will be delivered to investors over time. Using a single year of results as a metric is only appropriate if that single year of results can be considered a "sufficient statistic" that is representative of the entire future stream. At present, nothing could be further from the truth. Profit margins are 70 percent above historical norms."
The issue of high corporate profit margins seems to be gaining increased attention in recent months.
Notwithstanding the Federal Reserve's efforts to boost asset prices and force investors into riskier assets, we believe that valuation levels have become somewhat stretched.
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Those investors placing a heavy weight on price-to-earnings ratios that assume continued high profit margins are being overly simplistic.
Indeed, Fed Chairman Ben Bernanke is one of those "investors."
For our part, we remain invested but defensive. We have been through periods like this before, and we don't believe anyone can predict with any degree of certainty where the market is heading over the short term.
Like Warren Buffet, we are staying invested and will be looking for additional opportunities as the market presents them.
—By Michael K. Farr, president of Farr Miller & Washington and a CNBC contributor.