InvestingDaily.com

Account Information

  • My Account

    Manage all your subscriptions, update your address, email preferences and change your password.

  • Help Center

    Get answers to common service questions, ask the analyst or contact our customer service department.

  • My Stock Talk Profile

    Update your stock talk name and/or picture.



Close
FEATURED STRATEGY

Up an astonishing 1,192.8% with no end in sight

Get rich from the world's most BORING stocksI just published a report on my top 5 dividend stocks. One is up 630.8% since we added it to our portfolio. Another, I call “America’s best cash machine” because of its 8.2% yield. And a third is up 1,192.8%… with no end in sight. Best of all, these wonders pay juicy dividends and rake in top-notch gains in both bull AND bear markets. Get their names here.

 

Is the Magical Earnings Growth From Lower Taxes Sustainable?

By Linda McDonough on April 18, 2018

Will the real numbers please stand up?

Analyzing stocks is a tricky business in the best of times. Equity analysts and portfolio managers must decide what valuation method is the best one to use for a stock. They must decide how far out into the future to estimate earnings, what period of time they expect to hold a stock and how risky the stock might be.

The number of variables floating around when valuing a stock is dizzying.

However, most analysts use earnings estimates as a starting point. They use these numbers as a home base for screening stocks and deciding which ones are worth investing more time and effort in. Whether you are a value buyer, a momentum growth bull or a growth at a reasonable price player, you will likely begin your analysis with a consensus earnings estimate.

These are estimates that are compiled from various data feeds. FactSet, CapIQ, and Sentieo are some of the paid services that collect and distribute consensus earnings estimates. Many free sites like Yahoo Finance and Zacks include simple earnings estimates.

Depending on the stock, that consensus estimate might be the average of twenty analysts or just two. Nevertheless, these estimates matter and they tend to not stray too far from the crowd.

But the tax bill that just passed Congress is throwing a wrench into the estimate process.

You see, earnings estimates are the value of the after-tax earnings per share for each stock. For most public companies, tax rates don’t vary much from year to year. If there is a one-time event that hits the company with a much higher tax rate or a benefit that lowers it tremendously for the year, most will use an adjusted tax rate.

But the new tax code is not a one-time event that will be adjusted for. The basic assumption is that the new tax code, which grants most U.S. based companies a huge tax cut, will be in place until further notice.

My review of last quarter’s earnings results shows many companies enjoying a drop in their tax rate. The drop is as much as a 36% rate down to roughly 16%. These are HUGE drops, which deliver HUGE increases in earnings.

Think about it like this:

If a company earned $1.00 per share with a 36% tax rate but did not increase the pre-tax dollars earned by one penny, earnings per share would now equal $1.31 or thirty percent more with the lower 16% tax rate!

This is a remarkable magical feat. The question is- who will buy into it? Stock analysts by nature are trained to look at a stream of earnings over many years. A one-time rabbit out of a hat isn’t quite enough to convince me a stock is a good buy.

The big problem will arrive in 2019. The company that showed 30% earnings growth in 2018 due to a tax cut might now show no earnings growth at all. Obviously, the company may have introduced a new product or cut some expenses or made some changes to improve its operating metrics but all else staying the same, that stock is a show-me stock. It needs to prove to analysts that it can grow earnings.

This makes stock picking particularly treacherous right now. You may hear some talking heads crowing about “how cheap” stocks are. Technically that is true. However they may become cheaper, ie; drop in price, if they don’t prove that they can grow operating earnings.

I’ve always dug deeper into the estimates of the stocks I’m involved in to decipher from where the earnings growth is rising, but this year will require even more effort. I’m screening for stocks that are growing operating earnings or the old favorite EBITDA, for growth. EBITDA, that scary acronym for earnings before interest, taxes, interest, and depreciation, is a good marker for the cash earnings that a company can generate. It removes the noise of tax rates, interest payments, and non-cash charges.

It’s not perfect, but it’s a better metric than the smoke and mirrors being created by a one-time tax windfall.


You might also enjoy…

 

Forget Buy and Hold. Here’s how to retire faster…

I’m not a fan of “buy and hold.” Gurus like to tell you that patience is the key, but I call horse puckey.

We’ve discovered an investing technique that consistently pays out easy-to-repeat profits.

One that’s proven to beat the market 2,082% in head-to-head testing.

And one that’s generated over 488 winners since 2011.

This method is so powerful, in fact, some of the investors we’ve let use it reported back to us saying they’ve made $71,425… $82,371… and even as much as $151,000 in a single year thanks to this “trick.”

That’s how powerful this investing technique is!

What what exactly is this mysterious method? I’ve put all the details together here.

Stock Talk — Post a comment Comment Guidelines

Our Stock Talk section is reserved for productive dialogue pertaining to the content and portfolio recommendations of this service. We reserve the right to remove any comments we feel do not benefit other readers. If you have a general investment comment not related to this article, please post to our Stock Talk page. If you have a personal question about your subscription or need technical help, please contact our customer service team. And if you have any success stories to share with our analysts, they’re always happy to hear them. Note that we may use your kind words in our promotional materials. Thank you.

You must be logged in to post to Stock Talk OR create an account.

Create a new Investing Daily account

  • - OR -

* Investing Daily will use any information you provide in a manner consistent with our Privacy Policy. Your email address is used for account verification and will remain private.