Top Stocks Weak Due to Tax Selling

Some top stocks are feeling the pain this month as investors lock in gains for 2012 before the proposed tax increases come in 2013. To me this is the wrong strategy as all you need is a little bump up in stocks to offset the additional taxes.

The Fiscal Cliff Sounds Scary

First of all, I’m not into naming the tax increase “the fiscal cliff”. This tax increase has been inappropriately named “the fiscal cliff” because taxes are set to go back to levels we had earlier this decade. It sounds great if you’re in the media because falling off a cliff scares people and investors will more likey watch a segment on the fiscal cliff than say a tax increase. Its not exactly a cliff anyway — its just going back to the way things were.

Long term capital gains are really what stock investors should be concerned with. Regular investors are long term investors, and pay long term capital gains on stocks held more than a year. Right now that rate is 15% of profits made once the stock is sold. This rate used to be 20% of gains. Let’s assume the rate goes back to 20%, how much would your stocks have to rise to account for the additional taxes you would owe?

Don’t Sell Because of the Tax Rate

Let’s say you bought 100 shares of Apple (AAPL) years ago when the stock was $200. With the stock selling at $528 now, you have sizable gains. A tax advisor might tell you to sell the stock now and take the gains while you can pay the 15%. Here’s how the math works out:

Bought 100 AAPL @ $200 = $20,000,
Sell 100 AAPL @ $528 = $52,800
Taxable gain: $32,800
Tax Rate: 15%
Tax Due: $4920
Net Profit: $27,880

If  long term capital gains go back to 20% and AAPL gets a relief rally and rises 5% $555, here’s what you would pay/profit if you sold at $555 in January 2013:

Bought 100 AAPL @$200 = $20,000
Sold 100 AAPL @ $555= $55,500
Taxable Gain: $35,500
Tax Rate: 20%
Tax Due: $7100
Net Profit: $28,400

So all you need is a 5% rise in the stock to make more profit at a higher tax rate. Five percent isn’t a big deal, stocks often move one to two percent a day. AAPL was $590 — 11% higher — just last week. It’s not far fetched to think it can go back there by next month. By the way, $590 only 12 times earnings which I feel is the minumum most stocks should sell at.

Sharek’s Take

Stocks that have had great gains the past few years are now under pressure due to tax selling. But once this pressure is released in January I think the top stocks will rebound in a big way. In fact, some of these investors that are selling this month will buy back into the same stocks come January to get back their position. So not only will some selling pressure be relieved, but you will get a slew of buyers as well.

Apple is my largest holding, it’s been that way since 2009. The stock has given my investors great gains, but I feel the stock is being sold off unfairly because of the tax increase due in 2013. I think AAPL is worth at least $700 and will bounce back in a big way in early 2013.

My advice is to hold on to long term winners you’ve held for years. The recent selloff in stock market winners has put many of these stocks below their fair value and so you’d be getting out too low anyway. I feel the top stocks will rally as soon as the New Year rings in.