Trump’s announcement of ‘reciprocal tariffs’ with an effective rate of c.25% triggered a broad-based negative reaction from stock indices globally. The tariffs being proposed would be applied to the cost of the imported goods using the disclosed financial information for a company. We can use the Cost of Goods Sold (COGS) found in the income statement to approximate the cost to which the tariff is applied.
For example, if a company makes its product solely in the EU for €60/unit and exports them to the US, to be sold at a US dollar equivalent of €100/unit, the 25% tariff due to be applied on imports from the EU would be applied to the €60/unit COGS value, taking the total COGS to €75/unit. The company can either hike prices to cover this additional cost or make a lower profit per unit.
When analysing tariff exposure, we first have to estimate what percentage of COGS in America comes from outside the US. The higher the percentage of COGS that are made or sourced within the US, the less significant the exposure to tariffs.
We then focus on pricing power, or the extent that a company can increase the prices charged to customers without impacting volumes. Referring to the example above, if the company had no pricing power and had to absorb the cost of tariffs to protect its volumes, its gross margin would contract from 40% to 25%. In contrast, if it could successfully pass all of the tariff charges onto its customers, its gross margin would be maintained. Additionally, high initial gross margins are preferred as any tariff impact is likely to result in a smaller percentage change in gross margin than those with lower relative gross margins.
