Companies will not invest if they don't think investment wil

Posted on: November 9, 2017 at 15:53:55 CT

Companies only invest in equipment if they think the investment will earn a rate of return higher than the alternative use of the capital (opportunity cost) in the long run. That is a simplification but an accepted principle of finance.

If you go to extreme examples, you could argue that reducing taxes enough would result in such social dysfunction that profits would fall. For example, corporations depend on the legal system to collect consumer debts and arbitrate disputes. So if you defund government to such an extent that debt obligations can not be enforced, then yes, lower taxes would result in lower corporate profits. You could make a similar argument re: police protecting property. But within reasonable ranges of plausible scenarios, lower corporate taxes mean higher corporate profits. Higher corporate profits generally mean higher stock prices.

That is why people look at price/earnings multiples as a quick guide to finding undervalued and overvalued stocks.

But the industry standard is the discounted cash flow model, which is just a fancy way to saying you are calculating the net present value of the expected future cash flows the investment will generate.