All Stronger than One (Drip Port) April 15, 1999

<THE DRIP PORTFOLIO>
All Stronger than One
More on taxes and selling.

by Jeff Fischer (TMFJeff)

ALEXANDRIA, VA (April 15, 1999) -- Following up on yesterday's column, today we imagine that we sold Intel (Nasdaq: INTC) at the opening price of $58 1/2, following the suggestion of a full-service analyst. The analyst has a long-term attractive rating on the stock, but suggested it be sold because the summer could be slow.

This is Wise advice at its finest. It's ripe with contradiction and it's unconcerned with the reality of taxes, commissions, the inability to predict price movements (as the analyst is trying to do), and the fact that every investor must make decisions based on a very individual situation. When I addressed the analyst's sell proclamation yesterday, however, I was guilty of some inaccurate analysis as well. Math analysis, that is.

Although I needn't change any of my argument, I must correct the math behind it. In another example of the Fool community being much stronger (and more accurate, in sum) than any individual can consistently be, many of you posted on the message board that my tax computations were in error yesterday. Indeed! I stated that if we'd sold Intel at $57, as the analyst said to do, we'd pay a tax of 24% (on average) on the full $57 per share sale, meaning we'd need to see Intel at $43 (and buy it back then) before we could be "even" on our investment. In that light, the sale looks very stupid.

In another light, your Foolish correspondent (that's me) lacked a flashbulb over his head as well (to put it politely). We would only pay taxes on our actual capital gain in Intel, of course, not on the entire sale amount. Therefore, we need to correct the tax computations made yesterday (how apropos to have tax problems on April 15).

Our cost basis in Intel is $40, meaning that if we'd sold at $57, we'd have $17 per share in capital gains. If we paid an average tax of 24% on those gains, we'd pay about $4 per share in tax. That means that Intel would need to decline to $53 after we'd sold for us to be back to even. After adding commissions to sell and buy, let's say that we need a share price of $52.50 before we can buy Intel again and be even. So, the magic number is $52.50 in our example, rather than $43 as was cited yesterday.

The numbers change, but the point from yesterday remains the same: selling a strong company on a short-term concern is rarely a good idea due to immediate tax consequences. And the lower your cost basis, the poorer the idea of selling a good company is because the higher your tax bite will be. (Some investors would need to see a share price of $43 to be back to even!) One large problem with the sell advice yesterday, however, was that the stock was still rated a long-term attractive, so the sell was solely a short-term price prediction that didn't account for anyone's taxes -- and many Intel owners have owned shares for many years.

Several of you posted thoughts on the issue of selling and taxes on this portfolio's message board. As you showed by example, taxes aren't ever a cut-and-dried issue. There is, for example, tax loss selling that can be beneficial (at the Fool, though, we generally espouse the belief that you shouldn't sell a stock to benefit from tax losses alone -- there should be a fundamental reason behind any sell); there is also the issue of holding Intel in an IRA (then should investors "sell today" like it was suggested on television?); and finally, there is the fact that if we did sell now and bought back at $53, then when the stock rose from $53 back to $57 we'd be up 7.5% before taxes on it. That's a lot of ifs, though, and it means being taxed again the second time around. And, again, it's trying to time the market. (Foolish investors might rather hold what they already own and buy more on dips.)

Thank you to everyone who posted and who corrected the tax numbers Foolishly. Our community is one of the best in Cyberspace, if not the best. It's a community that allows for mistakes while supporting an open education for everyone. For that you're to be commended. Just a few of the good posts on the tax issue include this post, from ZuluFool, and this tax selling analysis from FoolOnTheSill. For all of the posts on the topic (there are about 10 quick reads) visit the Drip Companies board.

Beyond that, for formal analysis of taxes and investing, read Al Levit's recent Rule Maker Port columns on Taxes and Investing, Part 1 and Part 2. Great lessons!

Now, to again set our Foolish Accountability Stage, we're pretending that we listened to the analyst and sold Intel this morning at the open. That got us a price of $58 1/2 per share. We had a capital gain of $18.50, so we paid about $4.44 in taxes and almost another $0.60 per share (owning only about 19 shares) in commissions. We'll make it a round $5 per share that we in effect paid to sell our shares of Intel at $58.50. That means the stock needs to fall to $53.50 before we can buy back the same amount of shares that we just sold and be "even." But we're not waiting for $53.50. We're waiting for the analyst to tell us to buy again. We'll see what price he gets us in at. (When he says "buy," we'll be able to buy the next day, just as we sold the day after he said "sell.")

As for other stocks, Brian learned that Johnson & Johnson (NYSE: JNJ) will announce earnings next Tuesday, April 20. We'll cover the report. By the way, Pfizer (NYSE: PFE) declined today when it announced that Viagra sales slowed, but otherwise its first quarter report was strong and it met expectations.

To close: imagine if your mind took a vacation (ahem) and you paid taxes this year on the total sales amount for any stock you'd sold, rather than paying taxes only on capital gains. What a nightmare that would be! Either way, I'm glad I completed my taxes weeks ago.

Um... uh oh. Wait. OH NO! Noooooooooo! Noooooooooo!

(Just kidding. Fool on!)

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