Why Trump's Tax Plan Will Make It Much Harder To Analyze Corporate Earnings

For years now, we've been writing about the deception, falsification and accounting manipulation that large corporates use to spin their earnings reports. We've pointed out how corporate executives, often unable to affect any meaningful improvement in revenues or profits, are increasingly resorting to stock buybacks to goose EPS to help them hit incentive targets that are now commonly required to unlock extra incentive pay.

In fact, as we pointed out in October, Goldman's forecast of fund flows for 2018 shows corporates will once again be the single biggest buyer of stocks - some $550 billion, to be precise.

Corp

And now, thanks to a provision in the Trump tax bill that allows US corporates to pay a tax on repatriated cash and assets interest-free over a period of 10 years, reading earnings statements for many of the US's largest companies is about to become even more difficult for analysts, as the spaced-out tax payments that will distort a key metric of company valuation - a company's free cash flow.

Under the terms of the tax plan, companies must decide this year whether they want to pay the entire tax bill for their repatriation now, or instead stretch it out over ten years. Since the entire value of the tax (the "T" in EBITDA) will be incorporated into 2017 earnings - but the tax payment won't impact the company's free cash flow - as a result, firms will appear to generate more of their income from cash flows, as opposed to financial engineering - a quality that investors typically favor, per Wall Street Journal.

As the success of financial engineering causes the gap between GAAP and non-GAAP (engineered) earnings to swell - if one takes the average of the median DJIA median differences for the past 4 quarters (LTM), one gets  just over 14%  (and 15.8% if "normalizing" the latest quarter's data) - this is just one more factor that will make it more difficult for investors to ascertain the true financial help of some of the largest multinationals...

DJIA

The transition tax is being assessed on profits that US companies have generated overseas for years and held there, rather than having them taxed at the old US corporate tax rate of up to 35%. As part of the tax overhaul, the US is relinquishing its right to tax those profits and shifting to a “territorial” tax system, which will levy taxes only on profits generated in the US - but not before assessing a one-time tax on past earnings from the old system.


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