Why Tax Reform Benefits Tech ETFs

The Technology Select Sector SPDR XLK and other technology exchange-traded funds have recently slumped. A big reason why is an obvious sector rotation out of technology into financial services and other groups seen as beneficiaries of the Trump Administration's tax reform effort.

Investors shouldn't be hasty in dismissing XLK and other technology ETFs as viable tax reform plays. One element of tax reform that could lift technology stocks and ETFs is the potential repatriation of assets held overseas.

“In particular, there has been a lot of discussion about the potential repatriation of assets held overseas, namely cash,” said FactSet. “This is because U.S. domiciled companies have earned record profits overseas and have kept those earnings abroad to avoid paying the 35 percent U.S. rate.”

All About Apple

When the topic of U.S. companies holding cash overseas arises, it usually drifts to Apple Inc. AAPL. XLK, the largest tech ETF by assets, allocates almost 15 percent of its weight to Apple and another 11 percent to Microsoft Corporation MSFT.

“Apple currently derives over 60 percent of its revenue outside the U.S. As of the company’s latest annual report (data for September 30, 2017), Apple had accumulated $268.9 billion in cash and marketable securities on its balance sheet,” according to FactSet. “Of that, $252.8 billion is strategically stashed offshore, representing billions in tax savings.”

An estimated $2.5 trillion is held by U.S. companies offshore.

What To Do With That Cash

The 2004 tax holiday could prove instructive regarding what companies will do with their cash if they can repatriate it back to the U.S. without suffering tax penalties.

“From 2003 to 2005, 63 percent of the S&P 500 constituents increased their annual dividends,” said FactSet. “In 2003, a combined $30.3 billion in special dividends was paid to shareholders of S&P 500 constituents; this figure jumped to $179.4 billion in 2004, an increase of 492 percent. In 2005, aggregate special dividends fell to $49.2 billion. Of this $179.4 billion, a collective $149.8 billion (84 percent) came solely from companies in the GICS Information Technology sector.”

Microsoft was the biggest special dividend contributor in 2004 and 2005. In those two years, four XLK holdings were among the largest buyers of their own shares among S&P 500 member firms. Apple wasn't a dividend payer back then, but it is today. In fact, Apple and Microsoft are two of three largest U.S. dividend payers.

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