Why Tax Drama Will Blow Over for Apple Inc. Stock

Tax cuts are a huge positive for AAPL stock in the long run

By Ian Bezek, InvestorPlace Contributor

These 3 Factors Will Make or Break Tuesday’s Report From Apple

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The stock market finds itself in an interesting place this week. Following the Senate’s nail-biter 51-49 vote to approve the tax cut plan, stocks have made major moves. But they haven’t all been in the same direction. And Apple Inc. (NASDAQ:AAPL) is one of the stocks right at the center of the divergence. What’s going on here, and what will it mean for the AAPL stock price?

Many analysts, myself included, have pointed to tax reform as a key catalyst for AAPL stock going forward. It’s no secret that the company has an absurd amount of offshore cash. It has earned profits over the years and not brought them home to the U.S. due to an excessive tax obligation.

This legislation should change all that. In addition, as the most profitable company in the S&P 500, Apple earns gobs of money, and the overall reduction in corporate tax rates will make things much easier for Apple going forward.

The Great Divergence

Since last Wednesday, when the media first reported that the Republicans had enough votes to pass the tax bill, tech stocks and the rest of the market have gone in opposite directions. The overall market, most clearly shown by the Dow Jones Index, has spiked to new all-time highs. The Dow surged 300 points last Wednesday and was up as much as 250 more this Monday.

Tech stocks, as shown by the Nasdaq 100 Index, have not rallied. In fact, they’ve fallen close to 2.5% since the news broke Wednesday and are now at one-month lows. While AAPL stock has avoided a large selloff as of yet, its tech-giant peers are tumbling.

Nvidia Corporation (NASDAQ:NVDA) is the perfect demonstration. NVDA stock has plunged over the past week from $212 to a close yesterday under $187. Arista Networks Inc (NYSE:ANET), the must-own data-center networking stock of the year, has collapsed from $245 to $209 in just three days. And that’s with no company-specific news.

What the Tax Cuts Will Change

The reason for all these declines across the tech sector is that investors are now calculating the impact of the tax cuts on a sector-by-sector basis. Until this past week, many observers expected the tax package to fail altogether. Or that if it did pass, it would be quite watered down. Instead, the Republicans delivered something fairly close to what Trump had originally desired.

The corporate tax rate will be slashed dramatically from 35% to 25% or less. Deductions for local, state and property taxes will be reduced and in some cases outright eliminated. Many corporate tax deductions (or loopholes in some people’s opinion) will be going away, in part to pay for the overall tax rate reduction.

The net effect of these changes will be favorable to old-economy industries and less advantageous for most tech companies. Note that I said “most.” AAPL stock is an exception, but the market hasn’t figured that out yet. More in a second.

Bad News for Tech

However, for most tech companies, they earn relatively few profits in proportion to their market cap. NVDA, for example, has a $120-billion market cap but earns less than $3 billion a year in net income. A less sexy company trading at 15x earnings with the same market cap is, by comparison, earning $8 billion a year.

Slash the tax rate across the board from 35% to 20%, and the lower-PE company gets three times as much of a tax cut. Those savings go straight to the bottom line. The result is value stocks will see a far sharper hike in earnings than fast-growing tech firms.

And it gets worse. The corporate tax code is byzantine, and tech companies are among the biggest beneficiaries. With write-offs for capital expenses and research and numerous overseas tax loopholes, tech companies often pay far lower tax rates than the posted 35%.

Other U.S. industries, however, such as banks, food, retail and restaurants tend to pay far closer to the 35% posted rate. Stocks such as DineEquity Inc (NYSE:DIN), owner of Applebee’s and IHOP, rallied 10% on Monday alone as investors pieced together that it is getting a whopper of a tax break going forward. Numerous value stocks are running up sharply for similar reasons.

Apple Isn’t an Ordinary Tech Company

While Apple is a tech titan, it stands apart. Unlike many of its peers, it is highly profitable, has a down-to-earth PE ratio, and has tons of cash on hand. Thus, it benefits from cash repatriation, and it also earns a large portion of its market cap in profits every year.

These two things magnify the effect of the tax cuts on its earnings going forward. If you own AAPL stock, your future outlook — on an earnings and dividends basis — just got a lot brighter.

However, a lot of investors aren’t going through their holdings individually. Instead, they are taking the knee-jerk reaction of buying banks, packaged foods makers, retail plays and so on, while dumping ETFs that hold tech stocks. AAPL stock, as the biggest constituent of the Nasdaq 100, is highly weighted in the ETFs that investors now want to dump.

AAPL stock has fallen less than its sector, since some value players are coming in and buying the dip. And that looks like the right move, since Apple’s outlook brightens significantly once the tax bill becomes law. However, for the next few weeks, expect more selling in tech stocks. Investors will continue to rotate out of low-profit growth names into value-oriented cash cows.

Bottom Line on AAPL Stock

The Republicans have unleashed a tidal wave on the stock market. AAPL stock is uniquely positioned, given its advantageous tax position but also its location as the top dog in a sector that is suddenly being shunned.

Expect the AAPL stock price to outperform its FANG and semiconductor stock peers over the near term. But larger forces will likely keep AAPL stock from making a serious run at $200 per share for at least the next quarter now.

At the time of this writing, the author owned DIN stock. He had no positions in any of the other aforementioned securities. You can reach him on Twitter at @irbezek.

Article printed from InvestorPlace Media, https://investorplace.com/2017/12/why-tax-drama-will-blow-over-for-apple-stock/.

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