EDITOR'S LETTERMerryn Somerset Webb
The defensive stocks under fire
“US companies warn tax avoidance crackdown will hit earnings.” That was the headline on the front of the Financial Times last weekend. It seems that 136 large US firms have had to alert investors to the possibility that efforts by global governments to clamp down on aggressive tax avoidance are likely to hit their net profits. We started warning you a few years ago that this would happen. When countries need money, we said, they start showing firms what it means to be sovereign. When they need money, they go where the money is – and at the moment, it’s on corporate balance sheets.
So last year, the UK introduced its diverted profits tax, a 25% tax on contrived arrangements designed to avoid paying corporation tax here. Linkedin, Facebook and QLogic have all cited this as a risk. This year, George Osborne has announced that tax breaks on interest costs are to be cut. That, says the FT, will shave £1bn a year off corporate profits in the UK alone.
Add that to the OECD plan to stop “base erosion and profit shifting” and to the initiative to stop what is known as the “double Irish” method of tax avoidance (an old and lucrative favourite that involves moving profits to Ireland and then to a super-low-tax country) and you can see the way global tax policy is going.
As a letter, also to the FT, notes: “this is the beginning of a shift towards greater transparency and accountability in corporate tax arrangements that have been ignored by governments for far too long”. It might also be the start of a shift in the environment for the multinationals many of us have relied on for our returns for some time now. They have benefited hugely over the last 30 years from a plethora of cheap labour; a super-lax tax regime; and, of course, very low interest rates.
The first two are now clearly turning (Matthew Lynn’s article in this week’s issue on the sharp rise in the minimum wage) and the last is now having unhelpful perverse effects (it pushes up pension deficits and focuses too much attention on dividend yields). Look at the UK’s very big listed firms in this light and you might start to change the way you feel about them. Less defensive stalwarts, more giants in the line of fire?
If so, turn to my interview with Gervais Williams. He makes an excellent case for shifting your portfolio towards small caps and micro-caps in particular. They are, he says, more able to grow regardless of the economic climate. Find good small companies with cheapish shares that are capable of investing to increase productivity over time, and you will see the rewards in capital and dividend growth. That might sound a tall order to you. To Williams it isn’t. There are, he says, “plenty of pebbles” on the small-cap beach.
I persuaded him to run us through rather a lot of his favourites. You’ll be pleased to know that none of them have been shifting their profits through Ireland to Bermuda – so the global crackdown on this kind of thing won’t hurt them at all.