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Buffett: huge tax cut isn't baked into market

Warren Buffett believes that the corporate tax reform is very bullish for the US stock market, and more importantly, isn't fully priced in to stock prices.

"The tax act is a huge factor in valuation," he said on CNBC's "Squawk Box" on Wednesday. "You had this major change in the silent stock holder in American business who has been content with 35 percent... and now instead of getting 35 percent interest in the earnings they get a 21 percent and that makes the remaining stock more valuable."

The tax reform bill lowers the corporate tax rate to 21 percent from 35 percent. "I think 21 percent was not baked in. That's a huge reduction," he added.

Runnymede echos Buffett's sentiment. On Monday, I appeared on Reuters TV with Fred Katayama and I said, "With tax reform approved, I think a lot of those numbers (tax cuts) aren't baked into the market so the market is catching up to those expectations."

The example that I gave was Dollar Tree whose effective tax rate was close to 35 percent. With the tax cut, it gives them an additional $150 million in profit which can be used to increase pay, invest in expansion and return money to shareholders via buybacks and dividends.

Walmart and Waste Management giving raises and bonuses to employees

Companies are taking advantage of tax reform to make big headlines over the last 24 hours. Yesterday Waste Management announced that they would pay a $2000 to their 34,000 employees due to tax reform. By my calculations, over the last 12 months, Waste Management would save $290 million and they are giving their employees a $68 million payout, or a quarter of the tax savings. It remains to be seen what they intend to do with the other $222 million of potential additional cash.

This morning, Walmart announced that they will increase the minimum wage for its employees from $10 to $11 and also give employees a bonus of up to $1,000 based on service time. The increase in wages will cost the company an additional $300 million this year and the one time bonus will amount to $400 million. By my estimate, over the trailing 12 months, Walmart would save at least $1.5 billion in taxes so it is nice to see that they are giving close to 50 percent of the tax cut back to its employees.

It is clear that the corporate tax cut will provide stimulus to the economy. In this case, employees will have additional money to spend thanks to wage increases and/or bonuses. This money can cycle through the economy many times. Furthermore, the rest of the tax savings will likely to returned to shareholders via huge buyback programs and increased dividends. This should be very bullish for US stocks in 2018.

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About the Author: Chris Wang

Chris Wang

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