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Rule Reversal

During the past five years, U.S. companies have faced a wave of new rules, from stricter banking regulations to sweeping health care reform. Complying with changing regulations can cost time and money, potentially reducing a company’s earnings and hurting its stock performance.

But it would be a mistake to avoid companies simply because they happen to be in closely scrutinized sectors.

The greatest risk tends to arise not from the amount of regulation, but the possibility that regulations will change, bringing new compliance costs or forcing modifications to a company’s operations.

“Generally speaking, companies often learn to live with new rules as time goes by, and they become less of a factor,” says Brad Sorensen, Director of Market and Sector Analysis at the Schwab Center for Financial Research.

A case in point is the experience of the financial services sector following the 2007-08 financial crisis. That led to stricter regulations on lending and the amount of cash banks are required to keep on hand to weather future market turmoil. While the debate over the new rules—coupled with legal challenges stemming from the crisis—was a challenge to financial services stocks in the years following the crisis, most of the changing costs have been absorbed and investors have factored them into their expectations.

Meanwhile, health care stocks jumped in late June after the Supreme Court upheld the federal subsidies included in the Affordable Care Act (ACA), ending uncertainty over the outcome of a major challenge to the law. While the ACA has led to broad changes in the health care delivery model in recent years, at this point most provisions have been implemented and companies generally know what to expect.

“Investors shouldn’t ignore—nor should they obsess over—regulatory shifts,” Brad says. “Because regulations apply to almost every industry, and because companies typically figure out how to adapt to new rules, the potential for additional oversight shouldn’t be the lone consideration for a long-term investment decision.”

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Important Disclosures

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.


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