Tax Reform to Lift Some Stocks More Than Others

Higher-Quality Companies May Be More Likely to Sustain Tax Reform Benefits and Enhance Shareholder Value

By Kevin Toney & Mike Rode - November 2018

Corporate tax reform in 2017 created windfall profits in the short run. Longer term, we believe the skilled allocation of those higher profits will determine the relative winners and losers of tax reform.

Tax Reform Takeaways

One year out from the enactment of federal tax reform, we’re able to better identify long-term beneficiaries of the tax cuts. Our research shows that high-quality companies with leading market share, high returns on capital, low leverage, and strong management are most likely to deliver solid returns with less volatility over a full market cycle.

Several industries and individual companies immediately benefited from tax reform because reduced effective tax rates led to tax windfalls. Many companies rewarded shareholders with share repurchases, dividend increases and debt repayments. Some companies, like Apple, rewarded employees with one-time bonuses. We considered these capital allocation decisions and updated the fair market values and downside values for the companies in our investable universe of high-quality companies.

We Like the Long-Term Winners

Stock prices responded quickly to tax reform. Congress passed the legislation in December 2017, and by early 2018, investors adjusted market prices to reflect the law’s near-term benefits. However, we believe it’s critical to assess how capital allocation will affect long-term franchise sustainability, competitive positioning, returns on capital, and the ability to generate free cash flow.

Industries that have high barriers to entry, operate in a duopoly or oligopoly, and have a U.S. focus should see near- and long-term benefits.

More competitive industries, like grocery, may see their tax-reform benefits decline as they more aggressively compete on price. However, as time passes, we believe stronger, dominant players (Walmart and Kroger) should increase their already sizable market shares. Investments in digital capabilities will further extend their significant competitive advantage over smaller, regional players. Our research indicates such investments will also help them compete against the digitally savvy Amazon, which acquired Whole Foods Market in 2017.

Mike Rode
Mike Rode

Tax Reform: Playing the Long Game

November 2018: Investment Viewpoints

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      The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.