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On Thursday, Nov. 2, President Trump and Congressional Republicans unveiled a tax reform plan that would make sweeping changes to the nation’s tax code.
If enacted, the Trump tax plan would change the tax landscape for corporate America.
This year, the U.S. stock market has continued its nearly 10-year long bull market; that’s partly due in part to anticipation that the Trump tax plan would be a boost to corporations’ bottom lines. And while there are certainly aspects of the tax plan that are stimulative, there could be notable losers too.
Let’s examine which stocks investors might want to consider buying due to the Trump tax plan, and which stocks should be sold on the news.
How to Read the Tea Leaves
The Trump tax plan has multiple implications for U.S. stocks. First and foremost, the plan calls for a permanent reduction in the corporate tax rate, from 35% to 20%. This would be a huge relief for companies that pay lots of taxes, which are typically in high-margin industries.
In addition, Congressional Republicans have long sought a reduction in the repatriation tax, which is the tax levied on overseas earnings brought back into the U.S. The repatriation tax rate, currently at 35%, could be trimmed to as low as 10% in a one-time tax holiday.
Significant winners and losers would emerge from the Trump tax plan. The obvious winners are highly profitable companies with lots of cash held overseas. Think tech companies: Apple (NASDAQ: AAPL), Microsoft (NASDAQ: MSFT) and Cisco Systems (NASDAQ: CSCO).
These enormous tech companies are highly taxed thanks to their outsized profit margins. The income tax is substantial; Apple paid over $15 billion of income tax expense last fiscal year alone.
These tech companies hold a significant amount of their cash overseas. Combined, Apple, Cisco and Microsoft hold nearly $500 billion of cash and marketable securities on their balance sheets. Each of the companies has cash on hand in excess of 20% of its respective market capitalization.
Under the Trump tax plan, a repatriation tax holiday would incentivize these companies to bring back some of their cash hoards to the U.S.
That would be a big win for investors. Apple, Microsoft and Cisco could use repatriated cash to raise dividends and deploy more cash for share repurchases. That scenario also raises the possibility that the companies would dole out large special one-time dividends to shareholders.
Losers Under the Trump Tax Plan
Unfortunately, not all publicly traded companies stand to win from the Trump tax plan. In addition to lowering the corporate tax and boosting the likelihood of a repatriation tax holiday, the Trump tax plan calls for a significant change to the mortgage-interest tax deduction.
Currently, those who own homes worth up to $1 million can deduct a portion of the interest paid on their mortgage. The mortgage interest deduction is a widely-utilized (and popular) program that helps boost the housing market.
Under the Trump tax plan, the cap on homes eligible for the mortgage interest deduction would be reduced from $1 million to $500,000. On the day the tax plan was announced, homebuilder stocks fell across the board. Toll Brothers (NYSE: TOL) fell 6% on the day, while Lennar (NYSE: LEN) and KB Home (NYSE: KBH) each fell more than 3%.
After the Trump tax plan was unveiled, the CEO of the National Association of Home Builders, an influential industry group, predicted the changes could lead to a housing recession. More than seven million homes on the market are priced above $500,000. A reduction in the mortgage interest deduction would be a disincentive for homebuying, particularly at the high end.
The Republican tax plan also nearly doubles the standard deduction. This means fewer taxpayers would itemize and take the deduction, which could also be a headwind for the housing industry.
A Sweeping Overhaul
The Trump tax plan represents a potentially sweeping overhaul of the U.S. tax code. On the whole, it could be stimulative to the stock market. But there will be companies that do not benefit from the Trump tax plan, particularly among the homebuilding industries.
That said, tech stocks with high profit margins and huge percentages of cash held overseas are still attractive stocks to buy.
Disclosure: The author is personally long AAPL.