Market Beat: The corporate inversion controversy
August 21, 2014
The shares of Walgreen Co. recently suffered a large one-day drop in price. From the high on Aug. 5 to the low the next day on Aug. 6, the share price declined by more than 20 percent.
Remember the bell curve from statistics class where the average is in the middle of the curve and the outliers form the tails? Well, stock price distributions have what are known as "fat tails."
In a fat tail distribution, you get a normal shaped bell curve, but the tails can extend out a long way. What that means is that most of the time, stock prices will be fairly steady, but price moves of a larger magnitude than a normal probability distribution would predict can occur unexpectedly.
What happened to cause the rapid price drop in Walgreen's stock? They announced they are not going to invert and they are now targeting their earnings between $4.25 and $4.60 per share, compared with an earlier estimate of $5 per share.
You may be wondering what corporate inversion is. Inversion is when a U.S.-based corporation buys out a foreign one and relocates its headquarters to a foreign jurisdiction to obtain a more favorable tax rate.
The U.S. corporate tax rate is now the highest in the developed world, so there is strong incentive for businesses to relocate overseas and to not repatriate the money that is earned in foreign countries. Taxes are due if profits are brought back into the U.S but not if they're held overseas.
Inversion has become a political issue, as companies opting to invert have been labeled as being unpatriotic. In fact, public opinion was a consideration in Walgreen's decision not to invert.
Some industries are impacted more than others by the high U.S. tax rate, especially health care companies and retailers. Other industries have special loopholes and tax breaks available to them to offset their tax payments.
Investors should be aware of how changes in government policy can affect their portfolios. I don't know what will happen with our corporate tax code, but there is likely to be some active debate in the future about revising the code in general and policy changes that will eliminate the benefit in doing corporate inversions.
It would be nice to see some proposals on the table that would incentivize corporations to bring money home to spur growth and job creation.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.