The spending bill going through congress known as the Inflation Reduction Act (ACT- don’t get me started on the name), has caused confusion among investors as to how it may affect their assets. The ACT calls for a minimum 15% tax on major corporations. It also imposes a 1% tax on stock buybacks. Several estimates by investment analysts predict the ACT could reduce earnings in Fortune 500 companies by between 1-1.5%. If so, this would adversely affect investor values. Let me address very generally some concepts involved here that lead me to disagree in some measure with these analysts.
When I was quite young I started a lemonade stand. My first attempt failed as I had involved three friends and over the course of the morning we drank more lemonade than we sold. Not only did I not turn a profit but I was left with a debt to my mom that my friends abandoned me on.I learned some valuable business lessons from that effort.
From there I went on to sell popsicles at the ball field, candy bars at school, and soda at track meets. In each of these businesses I worked alone and had strict personal rules about not eating the profits. Each business taught me new lessons in timing, location, product selection and pricing. Regarding pricing I learned that a business had to be profitable. Though greed would lose me customers, not charging enough wasn’t worth my time. A reasonable profit margin had to be maintained, which meant prices were adjusted based on my time and costs. This was critical to keeping a loyal client base and running a successful business.
I believe the ACT may affect corporations, and thus investors, as follows. Any additional cost of doing business created by the ACT, including taxes, must be absorbed in some way. Cutting labor costs, reducing quality, raising prices or lowering investor returns are all possible. Corporations don’t simply “eat” higher costs, they must be passed on. Generally, the process will involve a mix of several items but, in the end, Fortune 500 companies, and my little lemonade stand, have to maintain a reasonable profit margin. It isn’t because they are greedy but because they need to stay in business. And if stock investors don’t earn a reasonable return, they will seek other places for their dollars.
Because of this, and since corporate profit margins on Wall Street (based on PE ratios) are currently close to historical norms, I don’t believe there is a lot of room to squeeze investor profits and still keep the investing public happy. This is especially true given the challenging times we have recently been through. Therefore, it is my expectation that the response, if the ACT is passed, will be for corporations to try and maintain current profit margins and cover the added costs in other ways. Keep in mind I have never run a Fortune 500 company, but I have run many lemonade stands, and the basic business principles are the same.
Dan Wyson, CFP® is author of “The Gold Egg," and “21 Financial Myths” and owner of Wyson Financial/Wealth Management 375 E. Riverside Dr. St. George, UT 84790 - 435-986-9525 – Securities and Advisory services offered through Commonwealth Financial Network, member FINRA/SIPC, a registered investment advisor