Tax re-rating

At what point do you factor in future tax rate hikes into PE multiples and DCF valuations?

We know there are tax rate hikes coming down the pike. We don't know when, what form they will take, what level they will be, or to whom they will apply.

It is probably a little too early to speculate on how it will shape out, but it is not unreasonable to get a feel for which firms and sectors are most exposed. At a guess, I would say energy, healthcare, financial services and potentially technology would be the most susceptible to targeted tax hikes (if that were to be the modus operandi). Mainly because they operate with high margins and are in politically expedient areas. A tax rate increase equates to an instantaneous downward shift of the cash flow stream. Assuming a tax rate rise from 36% to 39%, this equates to an approximate 4%-5% decline in earnings. How this affects the risk premia (ie. the multiples) is a little more difficult to gauge, but presumably it lowers the multiple because the after tax cash flow available for reinvestment is reduced.

The closest parallel from the recent past was probably the brouhaha over bringing options expense into income statements. At the end of the day it was a tempest in a tea cup, probably because option expense was already known from financial footnotes.

It remains to be seen whether uncertainty over tax rate rises will ruffle the markets. I haven't seen or heard much about it, yet!