Day 356: New Taxes?
Mother's Little Helper portfolio was UP today +$1,683.04 (+0.20%).
Overall GAIN YTD: +$266,590.86 (+45.66%).
Our benchmark index, the S&P 500 is up +19.85% Year To Date.
Be thankful that we don't get all the government we pay for.
- Will Rogers
First a disclaimer. It is not and never was the purpose of this blog to espouse my political opinions or that of any particular party. How I come down personally on the tax bill or anything else in politics is not relevant to this blog. It should be noted that my abstinence on politics and the fervor d' jour caused a number of subscriber defections throughout the year. My only responsibility was to create a portfolio to try and beat the broader market and to comment on the portfolio and the markets in general.
That said, please don't shoot the messenger, but I guess I can't ignore the topic of taxes any longer. Today, the President signed the Senates new tax bill into law. Opinions about the impact this new tax policy will have are as polarized as North and South. If you wish to indulge there are a great many resources available where you can read and listen to all perspectives; I have nothing to add here that will add value to that debate.
What does deserve comment here is how the tax bill will impact this portfolio and what if any companies might present a good investment opportunity in the new year as a result of the changes in tax policy and rates.
Pragmatism and Emotion
I'm a big believer in the power of pragmatism. To get through this next exercise requires that all other thoughts, emotions, religious and political beliefs be vanquished from you mind. To remove emotion and view a company with complete pragmatism requires that your mind be completely free to accept ideas that might otherwise cause you stress and to reward curiosity with yet more curiosity to learn anything and everything you can about what really makes the markets and publicly traded companies tick. You may be disgusted by the Senates new tax bill, but that shouldn't prevent you from seeing how to properly invest in this new environment. If you were dropped in an alien environment and had to learn to survive, would you learn the skills required to survive, or die complaining about your predicament?
Who Benefits from a Lower Rate?
This has to be the first question any investor should ask. Some of the answers may surprise you, some may be obvious. If we simply isolate the 21% corporate tax rate from the rest of the bill we get some clarity and can simply look for companies with a high tax rate; right? Wait, didn't we hear that most U.S companies don't pay that much in taxes anyway? How could a lower tax rate direct my investment money if U.S corporations aren't paying that 35% rate anyway?
In this blog we're stock pickers, we don't care about all the averages, we acre about what performs outside of the averages; we look for outliers. Turns out there are a bunch of corporations with very high effective tax rates. Write that down, 'Effective Tax Rate', the average number they actually paid. Effective tax rate is the average tax rate paid by the company on its earned income.
Locate net income on the company's income statement. This line may sometimes read "earnings." Net income shows how much revenue a company is able to keep after deducting taxes, and the two preceding line items should identify both revenue and taxes paid. The most straightforward way to calculate effective tax rate is to divide the income tax expenses by the income earned before taxes. For example, if a company earned $100,000 and paid $25,000 in taxes, the effective tax rate is equal to 25,000 / 100,000 or 0.25. In this case, you can clearly see that the company paid an average rate of 25% in taxes on income. This is not an exhaustive list but let's look at some companies that will see an immediate benefit from a lower tax rate.
Nucor Corp (NUE)
Nucor Corporation manufactures and sells steel and steel products in the United States and internationally. It operates in three segments: Steel Mills, Steel Products, and Raw Materials. Nucor has been a little out of favor since it's missed several earnings estimate this year. But if we look ahead to the growth in the U.S economy Nucor is looking like a pretty good bet. Provisions in the tax bill that benefit real estate development and investments in capital equipment directly benefit Nucor. If we add in infrastructure spending by state and federal government Nucor is bound to be a big winner. For the quarter just ended, Nucor paid an effective tax rate of 31.27%. Under the new corporate rate of 21% Nucor will see all that cash go directly to the bottom line. Nucor is already a leader in terms of being best of breed for high quality steel products and having the best run steel mills in the country. With 100% expensing Nucor can further expand their lead. We might also want to consider that Nucor will benefit from trade sanctions that are aimed at preventing foreign supplier from dumping below market rate steel in the U.S.
Fedex has been experiencing share price appreciation because of the growth in the economy. All thos online purchases from Amazon.com have to get delivered, Fedex benefits from all that eCommerce. However Fedex has a very high effective tax rate. The last five quarters effective tax rates were 31.96%, 39.31%, 30.14%, 37.49%, and 35.06%. Lowering Fedex's tax rate to 21% is a big deal because it returns 10%-18% back to earnings.
Schlumberger Limited supplies technology products and services to the oil and gas exploration and production industry worldwide in addition to services for reservoir imaging, monitoring, and development. Schlumberger is in a capital intensive industry, so 100% expensing should be an incentive to SLB to spend big, right away on new capital equipment. In the last quarter SLB reported an effective tax rate of 41.7%. With oil trying to test the $60 level and more rigs coming back on line in the U.S expect SLB's U.S operations to kick into high gear on real growth and with significantly lower taxes expect the share price to rise as well.
I love my Nordstrom brand shirts and even though the price has gone up I'll keep buying them. For several years though the street has said, 'buy the shirts not the stock'. Retailers like Nordstrom pay very high effective tax rates; try 41.6% ! The latest news out of Nordstrom hasn't been about a big ecommerce push, new services, expanded product lines or growing the number of stores and jobs; rather the dialog has all been about Nordstrom going private in order to survive. With an extra 20% added to earnings Nordtrom will have more options going forward and should be a great investment once again.
Here's a surprise, everything I hear in the news says Amazon doesn't pay any taxes, etc. etc. Amazon has a weird problem, as both a technology company and a retailer that operates in many jurisdictions their effective tax rate is all over the place. In the 3rd quarter Amazon reported an 18.35% rate, but in the 2nd quarter they had a 70.12% effective tax rate. Looking back further we see this wasn't an anomaly; first quarter 2017 was 24.03%, fourth quarter 2016 was 35.51% and third quarter 2016 was 46.64%. Imagine trying to plan business operations at any other company with tax rates that fluctuate like that. Having a stable 21% rate is a blessing to Amazon which should translate into continued stable low prices for consumers and more expansion. Amazon has more than 541,000 employees and is planning on hiring about 100,000 more over the coming year.
Centene is one of those companies you've probably never heard of. CNC is a diversified, multi-national healthcare enterprise that provides programs and services to government sponsored healthcare programs, focusing on under-insured and uninsured individuals. Over the last five quarters Centene paid an average effective tax rate of 43.68%. With an average analysts projection of $117 over the next 12 months we should see that number go higher when the analysts eventually calculate in a 50% tax reduction.
Who Benefits from Repatriated Cash?
This is another part of the tax bill that we can isolate and look just at companies that have lots of cash overseas. Under the new tax bill U.S. corporations are not offered the option to bring home overseas cash, they are taxed at 15.5% on cash and 8% on non-cash assets regardless of whether or not they bring it home. IN most cases we can assume they can do more with the money if they bring it home. The company we hear about most in the news is Apple with $252.3 billion dollars overseas. For Apple the one time tax break to repatriate overseas cash amounts to a sizable savings. Apple will pay 'just' $39 billion in taxes instead of the $88 billion that would have been paid under the old tax law.
While we here about Apple a lot because of the massive amount of cash they keep overseas, there is another way to look at who benefits the most by checking the amount of overseas cash as a percentage of the companies market capitalization.
Cisco has about $68 Billion overseas which is about 36% of market cap.