I’ve noticed that in a lot of the emails I’ve been getting recently, the emailer says something along the lines of “of course a U.S. corporate tax cut in 2018 is probably already priced into stocks”.
The Stock Market is Expensive
Stocks markets around the world – and in the U.S. especially – are very expensive right now. They’re overvalued. And no corporate tax cut being discussed would get close to increasing after-tax earnings enough to bring the normalized P/E on the overall market down to a normal level.
So, stocks generally are overpriced now before any tax cut and will still be overpriced after any corporate tax cut.
However, that’s not what matters to a stock picker. A stock picker chooses individual stocks. Factors like the price level of the stock market or the effective tax rate of the S&P 500 are irrelevant to a stock picker.
To a stock picker: it’s the prices of individual stocks and the taxes paid by those individual stocks that matter.
U.S. Stocks that Pay Higher Taxes Than Foreign Peers Aren’t Rising Faster Than Those Peers
The easiest comparison to make is between the big 5 advertising agency holding companies: Omnicom (U.S.), Interpublic (also U.S.), WPP (not U.S.), Publicis (not U.S.), and Dentsu (not U.S.). This is the easiest comparison because the 5 companies are comparable businesses and they are headquartered in different countries – yet they are all “multi-national” in the sense of where their profits come from.
If the market has already priced in a U.S. corporate tax cut – the EV/EBITDA (“DA” is rarely anything more substantial than an accounting charge at advertising companies) – of the U.S. ad agency stocks (that’s Omnicom and Interpublic) should have been rising versus the EV/EBITDA ratios of WPP, Publicis, and Dentsu as a U.S. corporate tax cut looked more and more likely.
What actually happened this year?
Shares in the big 5 global ad companies moved as if these were identical securities. Investors showed no preference for one stock over another. They certainly didn’t start preferring the U.S. ad stocks – Omnicom and Interpublic – over ad stocks elsewhere in the world as we approached year-end.
In fact, I got several emails from people asking whether they should buy WPP instead of Omnicom because WPP is cheaper. None of those emails mentioned that – since the financial crisis – Omnicom has paid much more in taxes than WPP. This may indicate investors are not focused on future tax rates when considering which stock to buy in an industry.
The Highest Taxed U.S. Stocks Aren’t Rising Faster Than Other Stocks
Because investors often think in terms of P/E ratios and other after-tax measures (like EPS), another way a U.S. corporate tax cut could be “priced in” to stocks is for those stocks paying the highest tax rates (that is, those converting the least amount of EBIT into EPS) to rise the most in price. These are