Credit Suisse’s Jonathan Golub called out his fellow Wall Street strategists this week for playing it too conservative in crunching the earnings boost from corporate tax cuts.
“Analysts have adjusted their 2018 forecasts by less than 2% for recent tax changes, a fraction of the likely impact,” he wrote.
Zach Scheidt of the Daily Reckoning blog agrees with Golub’s take, and he detailed his thoughts in a post Wednesday warning that anybody who’s investing based on these predictions is in for a big surprise as we move through 2018.
“I’ve seen analysts make some bad calls before, but this one really takes the cake,” he said. “Wall Street’s best and brightest are massively underestimating how much the new tax law will benefit companies’ bottom lines.”
Scheidt took a look at what a corporate tax cut from a top rate of 35% to 21% would mean for earnings and summarized it with this simple chart:
In other words, a company posting an after-tax profit of $3.25 in 2017 would report an after-tax profit of $3.95 under the new rules — a big improvement.
“Keep in mind, this projection doesn’t include any growth the underlying business may have in 2018,” Scheidt explained. “Earnings for this stock will jump by 21.5% simply because the company is paying less in taxes. For just about any stock, a 21.5% annual jump in earnings is a very attractive increase!”
And yet Wall Street earnings models have yet to reflect that.
“Some companies were already taking advantage of loopholes to reduce their taxes in 2017, so the net result may be muted a bit,” he said. “Even so, the benefit of lower tax rates will certainly have much more than a 2% increase in corporate earnings.”
Our first evidence of this potential upside arrives this week, as reports stream in from the likes of J.P. Morgan Chase
and Wells Fargo
Importantly, we’ll see what they have to say about their guidance in the coming year.
is a bit more cautious on the near term impact, saying the legislation “will muddy underlying company fundamentals.” The investment bank explained that “firms will be forced to remeasure the value of their deferred tax assets and liabilities at the new 21% statutory federal corporate tax rate.” This will results in a number of one-time charges.
“We expect investors to look through a noisy [fourth quarter] and focus on the effects of tax reform on 2018 [earnings per share],” Goldman told clients.
It’s those effects that has Scheidt feeling good about what’s to come. Specifically, he says small caps may benefit the most, considering they don’t have the big deductions and tax breaks offered to big Fortune 500 companies. An easy way to play that, he says, would be to buy the iShares Russell 2000 ETF
“Yes, the market has been running higher for nearly a decade now. And yes, there are some areas of the market that I am concerned about,” he wrote. “But the majority of stocks — and the market in general — should still have plenty of room to run.”