investing

How to Cash In on Corporate Tax Cuts

Investors can expect higher earnings and more generous dividends.

Stocks have been rising for months on hopes that tax cuts will fuel a surge in corporate profits and dividend increases. But you haven’t missed the rally—it should last well into 2018, especially for the parts of the market that may benefit the most.

One way to cash in is with shares of small and midsize firms. Such companies tend to pay taxes at higher effective rates than large multinationals (based on actual taxes paid), so those com­panies stand to save more from lower tax rates.

You can invest in this area with exchange-traded funds such as iShares Core S&P Small-Cap (symbol IJR, $80) and iShares Core S&P Mid-Cap (IJH, $196), a member of the Kiplinger ETF 20. Among individual stocks, consider domestic retailers Target (TGT, $77) and Ulta Beauty (ULTA, $237). Tax cuts should lift profits for both firms by at least 18% in 2018, and the stocks still look like good values, says brokerage and investment firm UBS.

New corporate tax breaks are also good news for dividend investors. Big companies are likely to repatriate large amounts of cash held abroad, partly because they can now pay tax on the money at reduced rates.Some of it will go for acquisitions and stock buybacks (which can increase earnings per share by reducing the amount of outstanding stock). But many firms will probably use some overseas cash—estimated at $1 trillion—to increase dividend payouts more than they would have without the tax changes.

Big drugmakers and technology companies have stockpiled a lot of cash abroad, making them good candidates to increase dividends. Johnson & Johnson (JNJ, $146)—one of our favorite dividend-paying stocks—could tap its estimated $41 billion in overseas cash to bolster its payout. The stock now yields 2.3%. Google parent Alphabet (GOOGL, $1,131), Apple (AAPL, $177) and Microsoft (MSFT, $90) have also amassed huge cash hoards overseas. With their businesses thriving, money they repatriate may lead to steeper dividend hikes.

But the tax overhaul is not all good news for cor­porate America. The new levy on foreign cash and profits will sting initially as companies start paying tax on those gains, potentially hurting their bottom lines in the short term. Apple, for instance, says it plans to repatriate much of its overseas cash—estimated at $252 billion—and reinvest some of it in the U.S. But the firm says it will pay $38 billion in taxes on that cash. Other firms, including banks such as Citigroup and Goldman Sachs, are taking big hits to their earnings as a result of the new repatriation tax, too.

And some parts of the market aren’t compelling regardless of tax cuts. Util­ities should get a big tax break from new rules that allow companies to deduct 100% of their spending for the next five years on capital equipment, such as factories and machinery. But utility stocks could face pressure in a market that favors faster-growing companies and those that thrive in an accelerating economy.

Banks and other financial stocks look appealing. Tax cuts could boost bank sector earnings by 10%, adding to an already healthy outlook for profits and dividends. Consider Financial Select Sector SPDR ETF (XLF, $29), also a member of the Kiplinger ETF 20, or, if you prefer individual stocks, JP Morgan Chase (JPM, $113) and M&T Bank (MTB, $179). Like utilities, industrial companies could get a boost from the rule allowing firms to deduct capital expenditures, accelerating demand for machinery and equipment. FedEx (FDX, $272) recently raised its earnings forecast for 2018 to account for the expected tax savings. We also like Fidelity MSCI Industrials Index (FIDU, $41), a fund we are adding to the Kip ETF 20.

Most Popular

25 Best Kirkland Products You Should Buy at Costco
Smart Buying

25 Best Kirkland Products You Should Buy at Costco

Many of warehouse club Costco's store-branded Kirkland Signature items get high marks for quality and value. Check out our picks.
July 21, 2021
Warning: You May Have to Pay Back Your Monthly Child Tax Credit Payments
Tax Breaks

Warning: You May Have to Pay Back Your Monthly Child Tax Credit Payments

Unlike stimulus checks, you might have to repay your monthly child tax credit payments if you get too much money from the IRS.
July 16, 2021
Will Monthly Child Tax Credit Payments Lower Your Tax Refund or Raise Your Tax Bill?
Tax Breaks

Will Monthly Child Tax Credit Payments Lower Your Tax Refund or Raise Your Tax Bill?

Everyone loves receiving large sums of money from Uncle Sam. But people who take advance child tax payments may take a hit on next year's tax refund.
July 31, 2021

Recommended

7 Ways to Prepare for Higher Taxes
tax planning

7 Ways to Prepare for Higher Taxes

The tax climate is changing, and your retirement planning strategies could use some tweaks to stay on top of the situation.
August 2, 2021
Readers Find Some Weird Winners
Investing for Income

Readers Find Some Weird Winners

Most of the time, I find flaws in offbeat investments with high distributions. But sometimes oddities have their day of glory.
July 30, 2021
How to Play the High-Yield Rally
Becoming an Investor

How to Play the High-Yield Rally

Junk bonds have been on a tear, so this fund has shifted to defense.
July 29, 2021
10 States with the Highest Gas Taxes
taxes

10 States with the Highest Gas Taxes

COVID-19 has made us appreciate driving our cars more, but filling up the tank will cost you more in these states.
July 28, 2021