Saturday, December 10, 2016

Corporate tax cuts: How big an impact on corporate profits?


From Pisani at CNBC not bad analysis.

Theoretically a 20% increase just from the tax rate reduction if firms can maintain sales/margins... does not take into account any increase in leading flows which may/may not manifest next year which would be or may be even more bullish.


President-elect Trump's proposed nominee for U.S. Treasury secretary, Steve Mnunchin, said on our air yesterday that the administration was still targeting a reduction in the corporate tax rate from 35 percent to 15 percent. 
The current 2017 estimate for the entire S&P 500 is roughly $131 per share. 
Thompson estimates that every 1 percentage point reduction in the corporate tax rate could "hypothetically" add $1.31 to 2017 earnings. 
So do the math: If there is a full 20 percentage point reduction in the tax rate (from 35 percent to 15 percent), that's $1.31 x 20 = $26.20. That implies an increase in earnings of close to 20 percent, or $157. 
What does that mean for stock prices? The S&P is currently trading at a multiple (PE ratio) of 17, high by historical standards. Applying that 17 multiple to earnings of $157, we get a price on the S&P 500 of roughly 2,669 for 2017. 
That is 469 points or roughly 20 percent above where it is today.




13 comments:

Unknown said...

Matt, while Trump is an economics major, I do not think he has a good handle on macroeconomics. Economics students, even at the graduate level, have a very hard time with macroeconomics. This is because microeconomics deals with individual behavior, and is therefore somewhat intuitive. However, macroeconomics deals with economic aggregates, and has very few links with microeconomic behavior. This lack of linkage led the economists to start the whole macro with micro-foundations - and that just does not work. The better way to go would have been to expand on Jay Forrester's work in systems dynamics, and on Hyman Minsky and Abba Lerner's work.

So in may mind, while the stock market going up will work after the corporate tax cuts, the macroeconomic effects are far less clear. While clearly these cuts will have an impact on Wall Street, I do not see the effects having a major impact on Main Street. If Main Street is doing well, Wall Street will do well. However, If only Wall Street is doing well, it does not mean that Main Street will do likewise.

Matt Franko said...

Unk,

I would pretty much agree with you here the one thing tho that I would point out is that Trump does have his eye on the external balance and this is different from the typical "trickle down!" type of approach of the past... looks like he intends to get the current account deficit down which should about balance the US budget and might get the "deficit!" people off his back...

I think what he is doing is equalizing the tax rates with the external sector and then he will go to the firms and say he did this for them so now they have no excuse to leave... iow it is a good deal for both sides firms get reduced US taxes and the US non-govt gets the jobs ... then if the firms dont take that deal, he'll go to all out war with them...

also stock market indexes should exhibit a one-time adjustment to the new reduced corporate tax rate reduction short term (up)....

Also, when he does the 'repatriation' thing that should result in USD based multinationals doing another one-time balance sheet modification like share buybacks which will also increase EPS and have a positive adjustment to the indexes one-off...

Beyond these one-offs you have to follow the fiscal flows to see how much the govt will be engaging on an on-going basis... that is still up in the air with Trump we dont know yet...



Matt Franko said...

PS I should add that it looks like the CR they just passed only allows for about a $25B discretionary YoY increase that is not even tepid at best...

so as usual of late the non-discretionary is going to have to do the heavy lifting for any YoY increase that is just SS/Meds demographics...

I'm hoping the Fed helps the non-discretionary this year with some big rate increases on the Treasury bonds if Trump spooks them with his fiscal moves... imo this is our best case scenario with these morons in control....

Tom Hickey said...

The problem with reducing the trade deficit by increasing tariffs is that low cost imports have offset wage suppression in the US. If low cost goods from China get more expensive and US wages don't rise fairly quickly from tax cuts and tax credits for infrastructure, there will be political pushback in 201 as the 99% gets crushed in a vise.

Matt Franko said...

"If low cost goods from China get more expensive and US wages don't rise fairly quickly"

I think prices will have to go up and also the wages probably for the people who have the jobs...

Tom Hickey said...

Coordination is the problem. Prices usually lead wages and if there is a lag, unrest rises. This is juggling with knives in politics.

Matt Franko said...

And the Fed probably wont just sit there doing nothing...

Tom Hickey said...

The problems that the new administration will face are essentially three-fold:

1. They have an economic plan that looks dodgy.

2. They aren't in control of the some the levers that need to be pulled to make the plan work to the degree it is sound.

3. They face fierce opposition both from the liberal and progressive Dems and also from sound finance-austertiiy wing of the GOP.

But all Trump has to do is accomplish about 20% of his goals against strong opposition prior to the midterms to keep the populists on board.

However, workers have to be doing better or see strong prospects of doing better by 2020.

Matt Franko said...

My top 3 would be:

1. They are "out of money!" morons

2. They are "out of money!" morons

and

3. They are "out of money!" morons.

Auburn Parks said...

I see that nobody has mentioned the fact that the entire premise in the quote is just silly. The impact on the market of a nominal 20% rate reduction would not have an effect anything like the simple math the author did. None of the major companies pay that rate, the effective rates (taxes that companies actually pay, not some made up 35% tax rate for the purpose of the authors calculations and guesses) are just about par for the OECD course.

IOW if you have a nominal rate of 35% and then tons of loopholes which allow companies to only pay about 15% on average

or if you have a 15% rate with no deductions\loopholes, then the macro economic difference between the two tax regimes if effectively nothing. So why would there be some magical impact in going for regime #1 to #2?

After all, the talk has always been about simplifying the tax code and reducing rates in a roughly revenue neutral type of way, which means absolutely jack shit for the economy as a whole.

Matt Franko said...

Auburn it varies depending on what is going on at the companies (non-cash expenses etc...)

Here:

http://insight.factset.com/2015/04/earningsinsight_4.17.15

I think what they are doing is taking the firm's EBITDA and then dividing the taxes by that to get an "effective" tax rate or something... as if taxes and depreciation and amortization are not real expenses or something...

Says the average tax paid was 866M so even if only 400 firms paid taxes that would be 346B total so 2/3rds of that would be about $200B....and SP500 earnings are about $1T so in at least short term this type of 20% effect to after tax earnings as long as firms can maintain price/margins...

Significant bullish for the index imo for sure cet par....

and as far as "the economy as a whole" ofc not that is not the mission of these firms that comes from some sort of crackpot libertarian philosophy.....



Auburn Parks said...

Franko-

my point is simply to focus on the flows. From my pov, the quoted logic goes "if rates go down by half, but prices\margins remain the same => stock prices should go up because the tax rates to margins ratio has gotten better from the corporate POV"

But rates are a meaningless sham in most cases because they have nothing to do with what huge corporations actually pay. So you cant do a guess based on rates to margins analysis, only on money actually paid in taxes to margins. And if the goal is revenue neutral corporate tax code reform, then the money actually paid in taxes wont change. IOW, the tax flow remains the same and so there should be no large impact in stock prices or any other aggregate economic indicator.

Matt Franko said...

"But rates are a meaningless sham in most cases because they have nothing to do with what huge corporations actually pay. "

They are not a meaningless sham they are used in computing the firms tax liability... the lower the tax rate the less taxes the firms pay cet par of other non-cash expenses...

Look here is a recent % of the SPs some firms that are doing well and hitting on all cylinders pay the 35% or higher "effective rate" than others who are struggling it depends on how well it is going:

https://www.nerdwallet.com/blog/investing/tax-rate-paid/

Again idk what these people mean by "effective rate" for certain... but if the firms are profitable after depreciation and amortization they pay 35%...