Foolish investors know that cash flow is the best indicator of a company's health. Yet not all cash is created equal. Thanks to the U.S. tax code, it's often prohibitively expensive for firms with foreign subsidiaries to bring overseas profits back home in cash, leaving it idle in overseas bank accounts. Unfortunately, while holding cash in foreign business units saves corporations on their taxes (a good thing), it can't be reinvested or distributed to shareholders (a bad thing).
Eager to keep the economic stimulus coming, Congress included a one-time deal for corporations in the 2005 corporate tax law, allowing them to repatriate cash earnings "permanently" held overseas at an effective 5.25% tax rate, provided they're used for job creation or economic growth. Companies like IBM (NYSE:IBM) and Intel (NASDAQ:INTC), with significant international business, have built up profits estimated to total anywhere from $420 billion to $750 billion that are just sitting idle. Analysts expect up to $320 billion of that will be repatriated, and because these profits have never been consolidated into the parent company, this one-time shot will juice earnings for big multinationals in 2005.
So far, only a few companies, including Duke Energy (NYSE:DUK) and 3M (NYSE:MMM), have committed to bringing cash home. Others, such as Motley Fool Income Investor pick H.J. Heinz (NYSE:HNZ) and tech giant Hewlett-Packard (NYSE:HPQ), have made indications, but no firm commitments, pending IRS clarification on the appropriate uses of the cash, which came last week. According to the tax man, executive compensation, stock buybacks, and dividends are off limits, but debt reduction, acquisitions, and possibly lawsuit payments are OK.
This massive inflow of profits should provide continued stimulus to the stock market this year, pushing the problem of slowed earnings growth out to 2006, when corporations will have to find serious opportunities or risk weaker comparisons to inflated 2005 numbers. Investors ought to be cautious about buying companies based on strong 2005 earnings, and hopefully companies will clearly separate the "real" from the "one-time" in their reporting.
With that said, the cash influx will do a lot of good for corporations, and their investors, especially when it comes to strengthening balance sheets. Debt reduction will be a popular use of cash this year, as will strategic acquisitions. Although it's technically off-limits, I still expect companies will find a way to distribute additional cash to shareholders (who's to say it's not coming from domestic operations?), either via stock buybacks or special dividends similar to last year's Microsoft (NASDAQ:MSFT) bonanza, only of less magnitude. Just be careful you don't get caught projecting future earnings off of this year's windfall.
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Fool contributor Chris Mallon owns shares of Microsoft through his private investment partnership.
