What corporate tax cuts mean for investors
Corporations receiving federal tax cuts have several ways to share the wealth with their investors. Marc Amateis offers some pros and cons of four top options.
Joel Dresang: Marc, let’s talk about corporate tax cuts and what those mean for investors. For a couple of years now, U.S. corporations have been sitting on hundreds of billions of dollars in cash. Now, they’re getting federal corporate tax cuts on top of that. They’re getting some incentives to bring money that was overseas back to the U.S. What should investors expect?
Marc Amateis: Joel, a company’s profitability depends on its earnings. When a company gets a tax cut, that’s a cut in expense, and it goes right to the bottom line, increases the company’s earnings, and that increases the company’s value over time.
Joel: So, focusing on the investors, companies have basically four things they can do with that extra cash. They could buy back shares. They could pay dividends. They could use the cash for mergers and acquisitions. They also could reinvest in their own operations. Let’s talk about those one by one and the repercussions for investors. Let’s start with share buybacks, because that’s at record levels now.
Marc: Right. Share buybacks, everything else being equal, is going to increase the stock price, because that just raises the earnings per share. You have fewer shares of stock splitting up the same pie, more earnings per share. But, you really have to be careful. A lot of companies make the mistake of buying back their own stock just because they don’t have anything else that they can think of to do with it, and they buy the stock back when the stock is at a high price. That’s not a very good use of that money.
Joel: What do you think about when companies use the extra money for shareholder dividends?
Marc: We like dividends. Dividends shows if the company has discipline. Companies that pay a good dividend, and also increase their dividend over time, have been shown to be very good capital allocators. And, those types of companies, over the long-term, their stock prices usually do pretty well.
Joel: What about when companies use extra money for mergers and acquisitions?
Marc: That can be a real benefit to a company, if it’s done properly. Imagine a pharmaceutical company buying a small biotech firm that has some good product in the pipeline. That can really add to a company’s earnings and profitability over time. That’s a great use of money. Again, you’ve got to be careful. You don’t want management that goes on a spending spree just because they don’t know what else to do with the money, and they make bad investments.
Joel: What about corporate reinvestment, when companies use the money for plants and equipment, research and development?
Marc: That’s one of the best ways to use the money, again, assuming that the management is doing it in the right fashion. You don’t want to see them just use the money to use the money. You want to see them doing things that will actually increase the value of a business, stick to their core business, not go outside their core business and try to be all things to all people. If they can do it the right way, clearly that’s a long-term benefit to the company and to the economy in general.
Joel: So, it sounds like investors can benefit in numbers of ways with these corporate tax cuts. Is there a way, a strategy, to make the most of that?
Marc: Well, one of the things that we talk about is passive versus active investing. And there’s a place for passive investing. It gives you broad exposure to the markets at a low price. But this is a place where active investing can really help. Imagine a mutual fund manager with his team of analysts that can really ferret out those companies that are doing the most good with the extra money that they have – investing in those companies versus some that maybe aren’t such good capital allocators. That’s kind of what you want to look for are those areas where the money’s being wisely spent. That increases the value of the company, and that increases the stock price over time.
Corporate cash to investors, a Money Talk Video with Isabelle Wiemero
Why dividends matter to investors, a Money Talk Video with Adam Baley
A place for active investment management, a Money Talk Video with Marc Amateis
(initially posted April 24, 2018)
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