Wall Street Journal, The Tax Law Is About to Make Analyzing Earnings Trickier:
The new U.S. tax law could throw a monkey wrench into a method many analysts and investors use to gauge the strength of companies’ earnings.
A provision of the tax overhaul enacted in December assesses a one-time tax on companies’ accumulated earnings from outside the U.S. But while the tax is typically charged to companies’ 2017 earnings, firms have the option of stretching the actual tax payment over the next eight years, interest free.
That decision, which companies need to make this year, could throw off the comparison of a company’s earnings to its cash flow, a traditional way of assessing earnings quality.
Investors like to see a company’s earnings fully backed by the cash its operations are generating. It demonstrates the company has the money to pay shareholder dividends and invest in its own future. But stretching out payments of the “transition tax” on foreign earnings will muddy that comparison, accounting experts say.
Many companies, including Microsoft and Johnson & Johnson, have already made the choice to stretch out the tax bill. That meant their 2017 earnings were reduced, but the year’s cash flow wasn’t, making it appear earnings were more fully backed by cash flow. Then, for the next several years, the companies’ cash flow will take a hit, while earnings aren’t affected, making it appear earnings are less backed by cash flow than they really are. ...
The disconnect between earnings and cash flow will force analysts and investors to do some reverse-engineering of company numbers to make sure they’re comparing apples to apples. If they don’t do so—or are unaware of the need to—they could be misled. ...
The transition tax is being assessed on profits that U.S. companies have generated overseas for years and held there, rather than having them taxed at the old U.S. corporate tax rate of up to 35%. As part of the tax overhaul, the U.S. is relinquishing its right to tax those profits and shifting to a “territorial” tax system, which will levy taxes only on profits generated in the U.S.—but not before assessing a one-time tax on past earnings from the old system.