Assessing Trump’s corporate tax cut
When Donald Trump’s nominee for treasury secretary, Steven Mnuchin, was asked this week what was at the top of his to- do list, the answer was likely music to the ears of chief executives and investors alike: corporate tax cuts and other tax reforms.
And Wall Street has good reason to be excited.
According to analysts, president- elect Trump’s pledge to reduce the U. S. corporate tax rate from 35 per cent to 15 per cent could boost earnings per share on the S&P 500 as much as nine per cent.
“It seems premature to build any such tax plan into forecasts, but the impact could be considerable if enacted,” said Citibank’s chief U. S. equity strategist, Tobias Levkovich, in a mid-November note.
What does this mean for investors? Well, it’s complicated, and analysts heed caution when assessing the bump from the presidentelect’s proposal.
“Single- factor dynamics are dangerous for investors. Out- and- out dangerous,” Levkovich said in an interview.
Tax laws are complex, varying widely for each company or sector, and the overall impact of a tax rate cut can be intertwined with other parts of Trump’s platform, such as deregulation, he said.
Nevertheless, here are some things to keep in mind when assessing if Trump’s tax cut will provide a bump for your portfolio.
HOW BIG COULD THE IMPACT BE?
Considerable, potentially. Even a more-moderate cut to 20 per cent, with no deductions, could add as much as US$ 12 to S& P 500 earnings per share on top of Citi’s current estimate of US$129, Levkovich said. That’s a 9.3-percent jump. Each additional percentage point of lower tax on pretax income would bring roughly US$ 1.75 per share of earnings.
Of course, Trump’s tax cut proposal could morph as it passes through different levels of government. A 20-percent corporate tax rate (as opposed to the promised 15 per cent) is what some analysts are using for calculations, given the House Committee on Ways and Means already has a tax cut proposed at that level, Levkovich said.
More important to watch is what happens to the effective tax rate: the rate that companies actually pay after the various tax deductions and credits available in the tax code that reduce the amount of tax owed.
While the U. S. corporate tax rate is 35 per cent, the effective tax rate is estimated to be an average 27 per cent, according to Citi.
If the incoming administration reduces the U. S. effective tax rate there would be a lasting effect, said Jonathan Golub, RBC Capital Markets chief equity strategist, based in New York.
“If we assume that we bring it down by five per cent, that would be approximately six to seven per cent benefit to S& P profits, not once, but in perpetuity,” said Golub. The overall impact on any single company will depend on what happens to existing corporate deductions, such as depreciation of research and development spending, and other potential offsets to a company’s overall tax bill.
“It’s almost like personal taxes,” said Golub. “It’s not the tax rate that matters, it’s whether you get to deduct your mortgage, or whether you can deduct your charitable contributions or childcare.”
As well, a boost in earnings on tax cuts may not be valued as highly in the market, said Levkovich.
“The corporate tax rate is going to be good in terms of, on aggregate, it will improve earnings for the S& P 500,” he said. “But you probably won’t get paid as much ... for a reduced corporate tax rate on earnings than you would if you had real operational leverage in the business.”
WHAT ARE THE CAVEATS? WHO WILL BENEFIT MOST?
Companies with the highest effective tax rates, in theory, stand to reap the greatest rewards from a cut.
“Those businesses that tend to be domestically oriented, like financials, like retailers, airlines, like drug distributors, tend to have higher tax rates,” said Golub, who included Best Buy, Gap and Wells Fargo in his list of 40 stocks poised to benefit from an all- Republican Washington.
Banks, in particular, are in a good position.
JPMorgan alone could see a 22.4- per- cent bump to its earnings per share under a 10- per- cent reduction in the federal corporate tax rate, according to a Nov. 27 research note on financial stocks by Keefe, Bruyette & Woods.
This r eduction could potentially bring down JPMorgan’s estimated 2018 effective tax rate from 35.7 per cent to 22.6 per cent, KBW’s research showed.
WHO WILL BENEFIT LEAST?
A company’s effective tax rate sometimes masks the dynamics in the background. Energy companies may have a relatively low rates — roughly 22 per cent — because of net- loss carry forwards ( the fate of which are still unclear under Trump), said Levkovich. Utility companies have relatively high effective tax rates ( 37 per cent), but the benefit from a reduction could be limited because utility commissions require them to refund that amount to rate base payers, he added.