Here is an investment problem worth considering.
The profitability of S&P 500 companies is now at an unprecedented stratospheric level; in the 98% percentile dating back to 1975, according to a recent report by Wall Street powerhouse Goldman Sachs
But at the same time, proposed increases in corporate tax rates could dampen profit growth. This should worry investors in the SPDR S&P 500 exchange-traded fund, which tracks the S&P 500.
First, business return on equity (ROE) over the past 12 months, a key measure of business profitability, jumped 4.8 percentage points to 19.6% at the end of the second quarter, according to the Goldman report. This increase was almost entirely due to an increase in profit margins, according to the analysis. A higher ROE is usually associated with higher long-term stock returns and vice versa.
The information technology, consumer discretionary and financials sectors have performed particularly well over the past four quarters.
Corporate taxation in 2022?
It’s good as far as it goes. What matters now is the future and this is where things start to look less rosy.
“We expect the outlook for ROE to become more difficult in 2022,” the Goldman report says. “Tax increases are the biggest potential obstacle to ROE growth in 2022.”
The proposed taxes include an increase in the current tax rate from 21% to 26.5% and global minimum tax rates on foreign income from 16.5%.
These new rates would affect profits by 5%, assuming other things don’t change, and profit margins would have to rise three-quarters of a percentage point to offset the negative impact of the tax hike, according to the report.
While an increase in profit margins is possible, it does not seem likely. In other words, don’t count on US businesses to reap even more profits from their businesses next year.
And this should be of concern to anyone with a stake in the stock market, as falling tax rates have been a key factor in increasing ROEs since 1975. Ultimately, a drop in ROE will mean a drop. stock returns over time.