During economic recoveries, corporate profits growth soars at double-digit rates as both revenues and profit margins rebound.
During the expansions that follow recoveries, corporate profits tend to grow around 6%-7% per year (Fig. 1 and Fig. 2). Trump’s tax cuts have made hash of this simple model.
Consider the following:
(1) Us, before and after TCJA. Without those tax cuts, Joe and I estimate that S&P 500 after-tax earnings per share would have increased at the 7% annual rate to $141 this year and $151 next year. Our back-of-the-envelope calculation is that the Tax Cut and Jobs Act (TCJA) enacted late last year will boost earnings by $6 this year to $147 per share, which would be a 12% y/y increase. Next year, the 7% trend resumes, with earnings rising to $158 per share. (See YRI S&P 500 Earnings Forecast.) Our $6 estimate is based on a pre-TCJA effective tax rate of 25% for the S&P 500.
(2) Them, before and after TCJA. Just before the TCJA’s December 22 enactment, industry analysts were projecting earnings of $146.26 per share for 2018 and $161.07 for 2019. Now just six weeks since then, they’ve raised their 2018 consensus estimate by $7.16 to $153.42 and their 2019 estimate by $7.87 to $168.94 (Fig. 3). Their estimates imply growth rates of 16.4% this year and 10.1% next year, compared to 11.2% and 10.1% before the TCJA.
Industry analysts have a well documented tendency to be too optimistic about the outlook for earnings further out and to lower their estimates approaching earnings seasons. The tax cut at the end of last year allowed them to add a significant amount to their already optimistic forecasts for 2018 and 2019. The tax cut should be fully reflected in their estimates once the current earnings season is over. Then we would expect to see their estimates coming back down closer to planet Earth.
(3) Q4 earnings season isn’t over. Joe reports: “We should get a broader consensus earnings boost not with the next TJCA Earnings Tracker report (which will be on 1/31 with data dated 1/25), but with the subsequent report due out 2/7 with data through 2/1, and thereafter for a few more weeks. It will pick up as earnings season kicks into high gear next week. Retailers will be the last to report, and after their estimates are adjusted for the TCJA, we can pick out final winners and laggards.” So by the end of the current earnings season, we should get a good handle on the one-shot impact of the tax cut on S&P 500 earnings, as well as which industries gained the most from the TCJA.
(4) P/E implications. If we use yesterday’s closing price for the S&P 500 and divide it by the analysts’ 2018 earnings estimate, we get a 2018 P/E of 18.6; using our estimate, we get 19.4. The comparable 2019 valuation multiples are 16.9 (theirs) vs 18.1 (ours).
(5) Implications of the analysts’ numbers. Let’s assume that the analysts’ current $7.16-per-share estimated boost to date for the one-shot impact of the TCJA on S&P 500 earnings is correct. We can use that increase to estimate the total tax savings to S&P 500 corporations and revenue loss to the US Treasury. Their number implies a 5% boost to earnings per share. The latest data available for aggregate S&P 500 net operating income is for Q3-2017 (Fig. 4). It was $1.1 trillion at an annual rate. A 5% increase would amount to a $54 billion recurring annual windfall from the permanent tax cut.
That would also be the amount by which the US Treasury’s revenues from corporate income taxes would be hit. Over the past 12 months through December, these revenues totaled $283 billion (Fig. 5). So the implied loss of $54 billion in corporate revenues from S&P 500 companies would bring this total down to $229 billion assuming all else equal over the next 12 months. Corporations weren’t paying much in US federal income taxes and will be paying at least 5% less after the TCJA (Fig. 6). Compare this drop to the 40% statutory corporate-tax-rate drop from 35% to 21%. This analysis confirms our view that corporations have been paying a much lower effective tax rate than 35%.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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