As the New Year approaches, investors are concerned that President Obama and Congress will decide to enforce higher tax rates on both capital gains and dividends in calendar year 2013. On May 17, 2006, President George W. Bush signed into law the Tax Increase Prevention and Reconciliation Act of 2005. While the legislation included multiple aspects of tax law, one of the noteworthy provisions was an extension of the 15% reduced tax rate on long-term capital gains and qualified dividend income. Originally, these beneficial tax rates were set to expire in 2010; however as a result of the financial crisis and economic recession, President Obama extended the Bush tax cuts through 2012 in a move widely viewed as compromise among Democrats and Republicans alike.
David Rosenberg, the former Chief North American Economist at Merrill Lynch, recently appeared on CNBC to express his opinion on the fiscal cliff and tax policy going forward. Regarding the possibility of increased taxes on qualified dividends, Rosenberg specifically stated, There's no evidence in the past [that] tax shifts in either direction have had a lingering impact on dividend growth, dividend yields place in the stock market. There could be a near-term impact, but its not an enduring one. I have written more extensively about Mr. Rosenberg's thoughts on investment allocation and why I respect his views in a previous commentary.
The purpose of this current article is to focus specifically on the near-term impact Rosenberg alluded to, and how forward-looking investors can capitalize on it. Here are four stocks I have labeled as victims of tax selling, either 1) due to profit taking on capital gains or 2) concerns over increased taxes on qualified dividends.
Apple (NASDAQ: AAPL): Apple shares reached an all-time intraday high of $705.07 on Sept. 21. This represents an enormous gain of 73% from Jan. 3, when shares were trading barely over $400. Â While one can attribute the subsequent decline in Apple shares to numerous factors and I agree, there was not a single factor in my opinion, tax selling has been an overlooked component of the supply brought onto the market. Wealth managers who saw an Obama reelection coming from late summer likely advised their clients to sell and take profits. Furthermore, once the trade in Apple became overcrowded and the iPhone 5 and iPad Mini launches were in the rearview mirror, it gave all parties involved further impetus to sell given there were no catalysts remaining for the calendar year. Whether you have a bullish, neutral, or bearish view on Apple going forward, in my opinion a portion of the October/early November weakness is related to tax selling.
Consolidated Edison (NYSE: ED): Unlike Apple, this $16 billion New York City utility operator experienced only modest share price appreciation through the third quarter. However, shares of Con Ed have been in a clear downward trend since Nov. 1 when the possibility of an Obama reelection seemed overwhelmingly likely. Investors are concerned over recent reports that qualified dividend income could be taxed at the much higher ordinary income rate beginning in 2013. While I personally view this scenario as unlikely, even if dividends are taxed at a higher 20% or 25% rate going forward, the tax effect is likely already baked into the stock price. In recent days, shares of Con Ed have exchanged hands in the $55 range, more than 15% below their all-time high of $65.98 reached earlier this year. Consider the example in the table below, which considers the effect of increasing qualified dividend tax rates on your cost basis of ED shares.
|
Cost basis in ED |
Annual payout | Effective yield | Qualified dividend tax rate | After-tax effective yield |
| $55.00 | $2.42 | 4.40% | 25% | 3.30% |
| $60.00 | $2.42 | 4.03% | 20% | 3.23% |
| $65.00 | $2.42 | 3.72% | 15% | 3.16% |
As the table illustrates, investors who purchase shares of ED at the current market price of $55 have a higher after-tax yield assuming a 25% tax rate than investors who own shares of ED at a cost basis of $65 and maintain the lower (expiring) 15% tax rate.
AT&T (NYSE: T): Shares of AT&T are being sold in similar fashion with that of Consolidated Edison. However, the telecommunications giant did rally significantly off its base level of $30.00 in January until reaching an early October high of $38.58, possibly in sympathy of Apple's pending iPhone 5 release. Since October, AT&T has lost approximately two-thirds of its gains for the year and now offers a 5.3% dividend yield. On Nov. 7, the company announced a quarterly increase in its dividend payout from 44 cents to 45 cents, or an increase from $1.76 to $1.80 a share on an annualized basis.
Whole Foods Market (NASDAQ: WFM): Shares of the Austin, Texas-founded natural and organic supermarket chain began the year around $70 before embarking on a gradual march higher, flirting with the $100 level from late August until mid October. The upward climb in Whole Foods has stalled at least temporarily since the company reported an in-line quarter on Nov. 7. The company also announced a $300 million increase in stock buyback authorization on Nov. 20. Goldman Sachs recently upgraded WFM from Neutral to Buy with a $106 price target, based on valuation and same-store sales growth. Piper Jaffray also made similar comments and reiterated a $105 price target.
If you are a believer that fears over the possibility for increased capital gain and dividend income tax rates are overblown, then now may be the right time to initiate a long-term position in any of the aforementioned companies. Personally, I am more of a believer.
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