- Stock ideas in 2017.
- Companies with huge offshore cash.
- The positive impact of Trump tax reform plan.
President Donald Trump inauguration has caused millions of protesters taken to the street to rally against the new U.S. president. It is also a day of celebration where the Dow hit 20,000 for the first time.
During the first week of the Donald Trump presidency, the new U.S. president wasted no time in withdrawing from the Trans-Pacific Partnership (TPP) and signs his first executive order to repeal Obamacare. Furthermore, he is also expected to renegotiate the North American Free Trade Agreement (NAFTA) and reform the current U.S. tax system. In this article, I share my analysis on how the Trump tax reform plan will create opportunities in the stock market.
1. Individual Tax Cut
President Donald Trump plans to lower the individual income tax. According to the tax breakdown structure above, the proposed Trump tax reform plan is to collapse the current (left) seven to three (right) tax brackets. For example, under single filer, the tax bracket for income between $91,150 to $112,500 will be reduced from 28 percent to 25 percent. With lower taxes, Americans will have more disposable income and growth in consumption. As such, this increased in consumption will increase corporate earnings, which lead to higher share price value of the individual stock.
However, it is argued that the Trump tax reform plan would only benefit the highest tax bracket with largest tax cut from 40 percent to 33 percent (7 percent tax cut). Instead, this tax reform plan could hurt the middle-class Americans whose income ranging from $112,500 to $190,150 which would see an increase in tax rate from 28 percent to 33 percent, as well as the lower income earners ranging from $0 to $9,275, would see an increase from 10 percent to 12 percent. It will be interesting to see how the final tax reform plan will turn out which is likely to have a positive impact on the stock market.
2. Corporate Repatriation Tax Holiday
In a globalized economy, companies have business operations worldwide. If companies based in the U.S. were to bring their profits earned in other countries back to the home country, these profits are being taxed at a one-time rate of 35 percent.
For example, Company A is an apparel retailer based in the U.S. and plans to expand into France. Profits from their France business operations are placed into a bank account in France. If company A were to move their cash back to the U.S., they will have to convert the Euros into US dollars and transfer the profits to their U.S. bank account where their profits will be taxed at a rate of 35 percent. As a result, many American companies did not bring their overseas profits back to the U.S. and report as much of their profits offshore as possible to avoid U.S. tax. According to Joint Committee on Taxation (JCT), multinationals have roughly $2.6 trillion profits held offshore.
The table above shows the Fortune 500 companies with biggest offshore holdings. Apple hoards the largest amount of its total cash offshore followed by General Electric. President Donald Trump plans to create a tax holiday for American companies to bring their profits held in overseas back to the U.S by reducing the current tax rate of 35 percent to 10 percent.
With a lower tax rate, American companies are likely to repatriate their overseas profits. Although the proposed tax repatriation plan has not yet finalized, repatriation of overseas profits back to the home country will help boost the economy by allowing companies to use the offshore cash to reinvest in their businesses to create more jobs. However, evidence of the previous 2004 repatriation tax holiday shown that it had not only caused an increase in the budget deficit and had also failed to create jobs as companies did not use the repatriated profits to invest in U.S. jobs instead of for other purposes. If these American companies are not using the repatriated profits for jobs creation, what do they do with the huge piles of repatriated cash and what does this mean for investors?
With the huge cash balance sitting on the company’s balance sheet, the company’s management can use the cash to maximize shareholder value through the following ways:
- Share buyback – Reduce the number of shares outstanding thus increasing earnings per share (EPS) and share prices.
- Reinvestment – Use the cash to reinvest in the company’s business to achieve higher growth and earnings.
- Dividend Payment – Rewards shareholder with special cash dividend payment.
- Merger & Acquisitions – Acquire other companies to gain greater market share.
If the Trump tax reform plan is finalized, sourcing for companies with huge offshore cash and solid fundamentals might be a great investment opportunity.
If you want to learn more about how to analyze and value these Fortune 500 companies, click on the picture below to join our Free Value Investing Masterclass.
Sam Shi Feng
Research Analyst, Mind Kinesis Value Investing Academy
Disclaimer: Please note that all information stated in this article is just for education purpose only and should not be used as any form of recommendation or advice.