US Companies paying 35%+ tax rates

[Guest Schwab711]

I didn't initially mean to end up in this position but nearly all of my holdings pay roughly 35% in taxes. I do think there is some political appetite for a lower corporate tax rate which would provide an immediate ~11% increase in IV across the board if tax rates were lowered from 35% to 25%. I'm a big believer in investing in quality companies with as many tailwinds (and as few headwinds) as possible (who isn't!). Instead of a single catalyst, I'd prefer to see multiple independent factors that may evolve into potential benefits for my investment. Any thoughts on the possibility and if others invest with similar tailwinds in mind?

 

*For comparison, a drop to 25% corporate tax rates sometime over the next 5 years is equivalent to seeing a price multiple expansion of 15 to 17 P/E at sale. Not a bad boost when combined with actual growth.

[Jurgis]

I think I'm with Buffett on this: a budget-neutral tax reform could be good, but unlikely to happen because of a lot of different agendas involved.

[constructive]

Given that corporate profit margins, inequality ratios, and government debt ratios are at or close to all time highs, I don't see significant corporate tax reduction as very likely.

[Jurgis]

Given that corporate profit margins, inequality ratios, and government debt ratios are at or close to all time highs, I don't see significant corporate tax reduction as very likely.

 

The rate drop perhaps could be offset by removing loopholes and subsidies to keep it revenue neutral and individual-neutral. (In other words, do not increase govt debt and do not increase individual income taxes).

 

But this is where Buffett says that it's impossible to agree on offsets because affected will cry wolf for their loopholes and subsidies...

 

So I guess I ultimately agree with you.

[Guest Schwab711]

Given that corporate profit margins, inequality ratios, and government debt ratios are at or close to all time highs, I don't see significant corporate tax reduction as very likely.

 

The rate drop perhaps could be offset by removing loopholes and subsidies to keep it revenue neutral and individual-neutral. (In other words, do not increase govt debt and do not increase individual income taxes).

 

But this is where Buffett says that it's impossible to agree on offsets because affected will cry wolf for their loopholes and subsidies...

 

So I guess I ultimately agree with you.

 

I don't necessarily buy into the argument that special interests will prevent change. It certainly raises the hurdle but many industries have seen significant regulatory change over the years. No one is immune if it makes sense and there's momentum (with that same thinking I don't think the ridiculous min wage increase will gain traction but that's a separate topic).

[Guest Schwab711]

I think the odds for a reduced corporate tax rate are high enough to drastically alter the IV of many US stocks. If a corp tax rate change does occur, then there are a lot of mispriced stocks at present.

 

Even if there is only a 50% probability of a 10% cut to the current max tax rate within 4 years, then an investor stands to gain an additional 1.5% CAGR on their investment, ceteris paribus.

Assumptions_and_Effects_of_Corp_Tax_Rate_Change.xlsm

[Investor20]

You will likely pay more if Hillary Wins unless you hold for more than 6 years. She has a sliding 6 years of short term capital gains. You only get long term capital gains after 6 years of holding.

 

http://taxfoundation.org/blog/details-hillary-clinton-s-capital-gains-tax-proposal

[Guest Schwab711]

You will likely pay more if Hillary Wins unless you hold for more than 6 years. She has a sliding 6 years of short term capital gains. You only get long term capital gains after 6 years of holding.

 

http://taxfoundation.org/blog/details-hillary-clinton-s-capital-gains-tax-proposal

 

Income tax rates are a whole 'nother animal. I have a strong opinion on this but it's not really the purpose of this thread. I don't really care to discuss whether any specific policy is any good for the country. I just want to handicap the future corp tax rates so I can arbitrage or exploit the changes.

[Investor20]

You will likely pay more if Hillary Wins unless you hold for more than 6 years. She has a sliding 6 years of short term capital gains. You only get long term capital gains after 6 years of holding.

 

http://taxfoundation.org/blog/details-hillary-clinton-s-capital-gains-tax-proposal

 

I just want to handicap the future corp tax rates so I can arbitrage or exploit the changes.

 

But the total taxes paid by investor is the Corp taxes + Income taxes.  The total probably will go up, not down unless you are using IRAs. It is a country with 20 trillion debt and growing.  The federal budget has no lee way to do anything - one can dream all they want and each politician can say whatever they want. I think your best bet is to buy these stocks in IRAs and if the Corp taxes go down and Capital gains go up, you will gain.

[Guest Schwab711]

The aggregate deficit has nothing to do with this thread. Either way, I don't think you are correct. If a lower corp tax rate came with an elimination of the deferred foreign income rule then the statutory tax rate would decline AND tax revenue would increase. I see an outcome similar to that as becoming more likely.

 

As an ex: MCO trades at ~22x 2015 FY net income. They had an eff tax rate of 36.1% (on $1.473b). If their tax rate was 25% then for increases to ~$5.44 (from $4.63 actual) and MCO is trading at 19.5x FY15 earnings.

MCO earnings eat for FY17 are $5.12. Assuming the same tax adj, FY17 fps would be $6.01 and MCO is trading at 17.6x fwd earnings.

 

If we look at GE in the same way, then GE's TTM eps falls from $0.72 to $0.58.

 

I think this is an interesting opportunity because it is so straightforward that it's an easy way to generate alpha, if it comes to fruition. Even if the probability of a tax rate change is 10%, the resulting effects are material for a lot of stocks.

[SharperDingaan]

Schwab ...

 

The majority of your holdings will not be paying 35%; they will be paying substantially less than that - if they weren't, their tax planners would have been fired long ago. Additionally, the tax tail does not wag the dog.

 

Your choices are to either sell & buy someone else less scrupulous over evading taxes, or stay with the quality business that you already have (ie: BRK). Would you really sell BRK, just because they weren't making their tax bill as low as humanly possible? The better quality sustainable firms typically recognize that paying their 'fair share' of tax, is the annual licensing fee for their societal 'license to operate'. It's part of their corporate social responsibility, & their share price usually reflects it.

 

SD

 

[Guest Schwab711]

Thanks for the reply. All of the  US companies with artificially low tax bills benefit from deferred foreign corporate income tax statute. This is a stupid loop-hole that exists because of lobbying. If closed, we could lower the tax rate for small businesses across the country and encourage more US investment.

 

Coincidentally, all of my investments would benefit from this tax change. In general, I agree with your sentiment that investors shouldn't buy/sell based solely on the company's tax rate.

 

This type of idea (tailwind) reflects my investing strategy of finding strong businesses selling for relatively cheap AND that have multiple potential catalysts or "tailwinds". I'd prefer real and present catalysts but they are usually expensive and already priced in. I like to try to position myself in investments where tailwinds are not recognized or do not exist yet, but there exists a non-trivial probability the tailwinds will be recognized in 0-3 years. I especially look for tailwinds that are market agnostic (secular demand or biz operation-dependent tailwinds - anything that's not reliant on multiple expansion).

 

If none of the potential tailwinds occur then I should get a solid, low double-digit return from the business operating as normal. If one or more of the tailwinds occur then I end up with a homerun (like FICO, ect). Basically, low risk/medium return investments with a low-probability of very high returns. Low risk means a company I'd feel comfortable allocating 10%+ of my portfolio to (to give an incomplete internal definition).

[DeepSouth]

Thanks for the reply. All of the  US companies with artificially low tax bills benefit from deferred foreign corporate income tax statute. This is a stupid loop-hole that exists because of lobbying.

 

It's not a stupid loop-hole and it's existed since the creation of the corporate income tax. The global corporate taxation system itself is crazy and an outlier in the OECD.

[randomep]

I think the odds for a reduced corporate tax rate are high enough to drastically alter the IV of many US stocks. If a corp tax rate change does occur, then there are a lot of mispriced stocks at present.

 

Even if there is only a 50% probability of a 10% cut to the current max tax rate within 4 years, then an investor stands to gain an additional 1.5% CAGR on their investment, ceteris paribus.

 

Why do you think corp tax cut is high enough probability? Are the prez candidates campaigning on that? Given how the 99% are royally pissed I cannot imagine any probability of corp tax cut.

 

 

[rb]

I'm also on the side that i don't see a high probability for changes in the corporate tax situation.

 

The tax code is a total mess on the corporate side. But any changes will produce winners and losers and the losers will tend to be larger companies with lots of money to lobby and derail the effort. For an effort to reform the tax code to be successful I'd say that a party needs to have the White House and large majorities in the House and Senate. Let's call that probability P(1). Then the probability that that party will want to tackle this hot mess, let's call that P(2).

 

Then P(tax overhaul)=P(1)xP(2). That's quite a small probability. Certainly not anywhere close to 50%. It's sad but it's where we are today.

[Jurgis]

Then P(tax overhaul)=P(1)xP(2). That's quite a small probability.

 

Sometimes I wonder how anything gets accomplished at all. :)

[Guest Schwab711]

Thanks for the reply. All of the  US companies with artificially low tax bills benefit from deferred foreign corporate income tax statute. This is a stupid loop-hole that exists because of lobbying.

 

It's not a stupid loop-hole and it's existed since the creation of the corporate income tax. The global corporate taxation system itself is crazy and an outlier in the OECD.

 

It was created in 1975 (iirc) to update our tax system for globalization. It unfairly benefits companies with IP vs real assets. Why should only certain types of biz gain a material advantage? I also think it's a leading contributor to US job loss.

 

I think it makes too much sense to update the corp tax code, though I'm certainly bias.

 

I have no opinion on a specific probability, just that it's materially above 0% over a 8 year period (to give an example - in reality it's a matrix of possibilities and I think a lot of those outcomes are feasible). Either way, its free optionality since no one is including it in valuations.

 

[DeepSouth]

Thanks for the reply. All of the  US companies with artificially low tax bills benefit from deferred foreign corporate income tax statute. This is a stupid loop-hole that exists because of lobbying.

 

It's not a stupid loop-hole and it's existed since the creation of the corporate income tax. The global corporate taxation system itself is crazy and an outlier in the OECD.

 

It was created in 1975 (iirc) to update our tax system for globalization. It unfairly benefits companies with IP vs real assets. Why should only certain types of biz gain a material advantage? I also think it's a leading contributor to US job loss.

 

I think it makes too much sense to update the corp tax code, though I'm certainly bias.

 

I have no opinion on a specific probability, just that it's materially above 0% over a 8 year period (to give an example - in reality it's a matrix of possibilities and I think a lot of those outcomes are feasible). Either way, its free optionality since no one is including it in valuations.

 

It benefits all American companies with global presences. It would be totally insane for the US government to actively harm the international subs of its corporate crown jewels. You're asking the US government to tax UK divisions of US businesses at 35-40% while UK domestic businesses are taxed at 20%; a massive hurdle to US international competitiveness. There's a reason why the OECD has hurriedly abandoned global corporate taxation systems; they're self-sabotaging.