Jan102014

Abercrombie and Fitch Sets Itself Up for More Disappointment

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disappointment

 

(A version of this article appears on TheStreet.com)

With low expectations shareholders of Abercrombie and Fitch (ANF) were rewarded during Thursday’s after hours trading as it was announced that the company experienced higher than expected sales for the fourth quarter to date.

Embattled CEO and Chairman Michael Jeffries needed a boost after calls for his resignation and having been the recent recipient of Herb Greenberg’s “Worst CEO of 2013 Award.” The 15% surge, if maintained into trading to end the week will leave shares only about 30% below their 52 week high.

Perhaps lost in the translation are the nuances contained in the report that sent shares soaring that may set Abercrombie and Fitch share holders up for more disappointment in the future. Manufactured good news has a way of doing that once reality hits and it is difficult to interpret today’s press release as anything other than a very favorable spin on a company and a personality much in need of spin.

For the period in question, which ended on January 4, 2014, the company actually reported decreased total sales, but found some solace in the fact that its direct to consumer sales were at its highest level of total sales than ever before. Of course, as the total pie shrinks a component may look comparatively better by simply not shrinking as much. The details of the direct to consumer activities was lacking. Its growth, was by all accounts, relative.

While sales were reported to be better than expected they represented a 4% decrease in the United States and a 10% decrease in international sales. Improved guidance was based on the nine week period ending before much of the east coast freeze that is reported to have stalled mall traffic. It’s unclear how nature’s elements will project forward as the first quarter becomes the object of focus. Additionally, reliance on”ongoing cost reduction efforts” is rarely a strategy for growth. Jeffries’ one year contract extension may require something more substantive than smoke and mirrors to further extend the engagement. Marketing the company as “We’re Not Sears” is not likely to provide a prolonged bounce, much as today’s press release may be suspect.

But I don’t really care about any of that, because Abercrombie and Fitch, for all of its dysfunction and sometimes embaarrassing behavior of its CEO, has been one of my favorite stocks since May 2012. During that period of time I’ve owned shares on 18 occasions.

Abercrombie and Fitch hasn’t been a holding for the faint of heart during that period, nor for anyone abiding by a buy and hold strategy.

As a punctuated buy and hold investor, my sales have been dictated by the call contracts I routinely sold on holdings, almost always utilizing in the money or very near the money strike levels.

Abercrombie and Fitch

Perhaps coincidentally the average cost of those shares has been $38.64, which was just slightly higher than the after hours trading peak after its more than $5 climb. During the period in question shares were initiated at $35.15 and soared as high as $55.23 almost a year to the date of that opening position. A perfect market timer could have sold shares at the peak ans achieved a 59% return with dividends.

Not only am I not a perfect market timer, but I’m also not very patient and would have had a hard time holding onto shares for a full year. Instead my shares were held for reasonably short periods of time, other than one lot currently open for 4 months. During that time the cumulative return has been 56% while the shares themselves have appreciated less than 11% from the date of first purchase.

With some of my shares set to expire on Friday January 10, 2014 amd some others the very next week, there is a chance that I will be left with no shares, thanks to a well timed press release.

However, I have no doubts that Abercrombie and Fitch will find a way to undo investor goodwill and will see its price come down. When it does, I will be there, once again, eager to pick up the wounded shares of of a company that would be embarrassed to have me as a customer.

Dec272013

When to Take Tax Losses

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(A version of this article appeared in TheStreet.com).

Each year the ritual begins just days before New Years. Even in the best of years there are bound to be some losers. Fortunately, whatever faults there may be in the tax code, the ability to attenuate investment mistakes isn’t one of them.

Since I actively sell covered options and generate taxable premiums the thought of offsetting gains is appealing, but before jumping at the opportunity a grasp of history may be helpful.
In this case looking at the strategic tax losses taken in 2012 I’m struck by one thing. Four out of the five such sales saw shares appreciate more than the S&P 500’s gain for 2013. Not only did they gain more than 29% from their sales price, but they also gained more than 29 % from their purchase prices.
Proponents of the “Dogs of the Dow Theory” would readily understand the phenomenon, as perhaps should serial covered option writers who repeatedly write options on the same stocks as their prices regularly go up and down, sometimes even to extremes, yet so often recover.
Given the choice between taking a tax credit or a stock loss or paying more taxes because of greater gains, I would take the latter every time. However, there is a preponderance of thought that losses should be taken if they reach the 10% level. For those believing in rules, this is a useful rule, if consistently practiced.

Unfortunately, there is no guarantee that proceeds from the sale of losers will be recycled into the shares of winners. Sometimes losers simply give way to other losers, as even well devised ideas don’t alwaysbear fruit. While hindsight often has me wishing I had cut my losses, the real battle is deciding whether to follow your humble or arrogant side.

The arrogant side believes it can re-invest loser proceeds and recover losses. The humble side wonders how someone so ill-advised and having made the original investment, then sat frozenly while shares plunged, could now suddenly be deft enough to select a winner, instead of inviting ruination once again.
It’s difficult to not take the humble side’s argument. Logic trumps hope.
The decision process as to whether to take tax losses begins with understanding your tax liability, which is related to your marginal tax rate. If in the highest Federal tax bracket, the short term rate on capital gains is 39.6%, although the rate varies from 10 to 39.6%.

Next comes a look at the probabilities of various outcomes and their respective benefits.
There is a 100% probability that the loss will decrease your tax liability, if you didn’t violate the Wash Sales Rules. It’s hard to beat those odds, but if you do buy and sell the same stock repeatedly, as I often do, the 30 day window on either side of your proposed trade can scuttle your strategy.
The next step takes some calculation.

As an example, I’m going to look at Petrobras (PBR) shares that I bought on January 7, 2013 at $20.05 and currently trading at $13.48. An advanced degree is mathematics is unnecessary to recognize that represents more than a 10% decline and would violate investing rules sometimes attributed to famed financier Bernard Baruch.
The potential tax benefit is based upon your tax rate and whether the holding is a short term or long term. As a short term holding the Petrobras position is entitled up to a 39.6% credit against capital gains, meaning that credit can be worth up to $2.60 per share.

While that is an objective calculation, the next step is entirely subjective and focuses on your assessment of the probability that Petrobras shares will add $2.60 to its current share price. How likely is it that shares will gain 19.3%?  While there may be be company specific challenges, as well as broader economic challenges to consider, one may be justified in wondering whether Petrobras will be this year’s Hewlett Packard (HPQ), which was a strategic tax loss that I mistakenly took last year and is up 99% YTD.

If you believe that such lightning may strike twice in a lifetime you may decide to roll the dice and surrender the certainty of a short term tax credit.

if your educated gamble is right, even at the new higher price yomay still qualify for a tax loss, however, you’ll find yourself looking at a much ower credit, if the short term loss becomes a long term loss. As a movie character once asked, “are you feeling lucky?” If you can generate some option premiums along the way you can make your own luck, but whatever the outcome, it is deferred to 2015, which may entail further opportunity costs.

Then again, just look at your losers from last year. Unlikely as it may have seemed, recovery wasn’t outside the realm of possibility.

Bottom line? Ask your tax advisor, but do so soon.

Dec272013

When to Take Tax Losses

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(A version of this article appeared in TheStreet.com).

Each year the ritual begins just days before New Years. Even in the best of years there are bound to be some losers. Fortunately, whatever faults there may be in the tax code, the ability to attenuate investment mistakes isn’t one of them.

Since I actively sell covered options and generate taxable premiums the thought of offsetting gains is appealing, but before jumping at the opportunity a grasp of history may be helpful.
In this case looking at the strategic tax losses taken in 2012 I’m struck by one thing. Four out of the five such sales saw shares appreciate more than the S&P 500’s gain for 2013. Not only did they gain more than 29% from their sales price, but they also gained more than 29 % from their purchase prices.
Proponents of the “Dogs of the Dow Theory” would readily understand the phenomenon, as perhaps should serial covered option writers who repeatedly write options on the same stocks as their prices regularly go up and down, sometimes even to extremes, yet so often recover.
Given the choice between taking a tax credit or a stock loss or paying more taxes because of greater gains, I would take the latter every time. However, there is a preponderance of thought that losses should be taken if they reach the 10% level. For those believing in rules, this is a useful rule, if consistently practiced.

Unfortunately, there is no guarantee that proceeds from the sale of losers will be recycled into the shares of winners. Sometimes losers simply give way to other losers, as even well devised ideas don’t alwaysbear fruit. While hindsight often has me wishing I had cut my losses, the real battle is deciding whether to follow your humble or arrogant side.

The arrogant side believes it can re-invest loser proceeds and recover losses. The humble side wonders how someone so ill-advised and having made the original investment, then sat frozenly while shares plunged, could now suddenly be deft enough to select a winner, instead of inviting ruination once again.
It’s difficult to not take the humble side’s argument. Logic trumps hope.
The decision process as to whether to take tax losses begins with understanding your tax liability, which is related to your marginal tax rate. If in the highest Federal tax bracket, the short term rate on capital gains is 39.6%, although the rate varies from 10 to 39.6%.

Next comes a look at the probabilities of various outcomes and their respective benefits.
There is a 100% probability that the loss will decrease your tax liability, if you didn’t violate the Wash Sales Rules. It’s hard to beat those odds, but if you do buy and sell the same stock repeatedly, as I often do, the 30 day window on either side of your proposed trade can scuttle your strategy.
The next step takes some calculation.

As an example, I’m going to look at Petrobras (PBR) shares that I bought on January 7, 2013 at $20.05 and currently trading at $13.48. An advanced degree is mathematics is unnecessary to recognize that represents more than a 10% decline and would violate investing rules sometimes attributed to famed financier Bernard Baruch.
The potential tax benefit is based upon your tax rate and whether the holding is a short term or long term. As a short term holding the Petrobras position is entitled up to a 39.6% credit against capital gains, meaning that credit can be worth up to $2.60 per share.

While that is an objective calculation, the next step is entirely subjective and focuses on your assessment of the probability that Petrobras shares will add $2.60 to its current share price. How likely is it that shares will gain 19.3%?  While there may be be company specific challenges, as well as broader economic challenges to consider, one may be justified in wondering whether Petrobras will be this year’s Hewlett Packard (HPQ), which was a strategic tax loss that I mistakenly took last year and is up 99% YTD.

If you believe that such lightning may strike twice in a lifetime you may decide to roll the dice and surrender the certainty of a short term tax credit.

if your educated gamble is right, even at the new higher price yomay still qualify for a tax loss, however, you’ll find yourself looking at a much ower credit, if the short term loss becomes a long term loss. As a movie character once asked, “are you feeling lucky?” If you can generate some option premiums along the way you can make your own luck, but whatever the outcome, it is deferred to 2015, which may entail further opportunity costs.

Then again, just look at your losers from last year. Unlikely as it may have seemed, recovery wasn’t outside the realm of possibility.

Bottom line? Ask your tax advisor, but do so soon.

Dec262013

2013 Strategic Tax Losses

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It’s that time of the year to sadly sit and accept some reality and see if there are any strategic tax losses to offset trading gains. That is a gift in the tax code and just about the only thing that makes taking a loss palatable for me.

Before I go on, I’m not an accountant. I’m not even a Pediatric Dentist anymore. I’m not really certain what I am, other than to be someone faced with the same pragmatic issues as most investors, even in a year that everything seemed to just go higher and higher in share price.

Before considering what strategic tax losses I may decide to take this year, as the calendar is growing short, I find it useful to look back in time at the tax loss selections in 2012. .

The strategic tax loss sales I sustained last year were  on specific lots of Chesapeake Energy ($17.36),  Hewlett Packard ($13.66), ProShares UltraShort Silver ($51.09), Groupon ($4.79) and Potash ($40.07). The fact that other lots of those stocks may have delivered profits in 2012 is irrelevant and didn’t soothe the angst of parting under such sad circumstances. (CHK), (HPQ), (ZSL), (GRPN), (POT)

So where are they now after a year that has seen about a 28.5% gain in the S&P 500? Is there life after loss?

Their closing prices on December 24, 2013 were: Chesapeake Energy ($27.61), Hewlett Packard ($28.18), ProSharesUltraShort Silver ($90.02), Groupon ($11.83) and Potash ($32.82).

With the exception of Potash, all of those have had more than a 28% gain from their sales price and, in fact, more than a 28% gain from their purchase prices, as well.

The reason this isn’t too surprising is for the same reason that the “Dogs of the Dow” theory has been a reasonably reliable prediction tool. In general, if you invest in a company that isn’t likely to disappear in the near future or go bankrupt, there’s a very good chance that it will rebound strongly after a period of abysmal performance. Decent companies tend not to stay at depressed levels if the market around them is healthy. There are obviously exceptions to that generality, but how many stocks don’t display regular ups and downs in the charts, even to the point of periodic extremes?

Having looked, over about 30 years of investing results, very few “losers” failed to redeem themselves. That may be due in part to serendipity, but also from shunning really speculative issues. Back in the days when I had a stock broker, and I really did like and respect him, it was actually maddening to see how frequently stocks that had been sold for a loss had recovered. Given the choice between taking a tax credit or a stock loss or paying more taxes because of greater gains, I would take the latter every time.

However, my broker was a firm believer in taking losses if they hit the 10% level, which is a very traditional approach. To his credit, he followed his rules and was consistent in his application of those rules.

Consistency is what is ultimately one of the most important things when managing investments, even though there may be other paths to the same destination.

What I had also noticed was that there was no guarantee that the proceeds from the sale of losers past would then be recycled into shares of winners. Sometimes losers begat losers and sometimes losers begat winners. To a large degree the direction of the overall market was a factor in where individual stocks would go, especially if looking at an entire portfolio. However, even beautifully woven theses didn’t always go as envisioned and occasionally losses mounted, even though the intentions were honorable, but restricted by protocol.

In hindsight I always believe that when holding a loser I should have followed that 10% rule, but then you realize that the real dynamic at play is deciding whether to follow your humble or arrogant side into battle.

The arrogant side believes that it can take the money from the sale of a loser, re-invest it and recover the losses. The humble side wonders how it could be that someone so stupid as to have made the original investment in the first place and then watch it go down so much, could now possibly be smart enough to immediately pick a winner, instead of doing the same thing all over again.

For me, it’s hard not to take the humble side’s argument. Logic prevails in that argument over blind hope.

So where to begin?

Assuming that you are in the highest Federal tax brackets in 2013, the short term tax rate is 39.6%, although the rate will vary from 10 to 39.6% and doesn’t include state tax rates, if any. 

As always, your losses are limited to $3,000 in excess of your reported gains, with the ability to carry over additional losses to subsequent tax years. I’m desperately hoping that no one is reporting net losses, but rather looking to reduce their taxable liability.

That means that selling a losing stock gives you a credit against your gains, which includes option premium derived income, which is always taxed at the short term rate. If you do a lot of covered option selling you then may very well have a need or at least a desire to see whether there are any steps that can be taken to reduce your tax liability.

To make the decision of whether to take a strategic loss you have to look at the probabilities of various outcomes.

The first is the 100% probability that if taking the loss you will get a credit to your tax liability, subject to Wash Sales Rules. It’s hard to beat those odds, but if you do practice the serial kind of buy/write trades, as I often do, you also need to have a very good understanding of the wash sales rule and be very mindful of the 30 day window on either side of your strategic tax loss trade.

The next step takes some calculation.

As an example, I’m going to look at JC Penney (JCP) shares that I bought on July 30, 2013 at $16.16 and currently trading at $8.75. These values are not adjusted to reflect any option premiums collected. It doesn’t take a mathematics savant to know that is a loss well in excess of 10%. If Bernard Baruch were still alive he would slap me silly, as corporal punishment was still acceptable in his day.

The potential tax related advantage is based upon your tax rate and whether the holding is a short term or long term holding, with a one year period being the dividing line between the two. As a short term holding the JC Penney position is entitled up to a 39.6% credit against capital gains. In this case that credit can be worth up to $2.93 per share.

However, the next step involves the second probability in the equation. What do you believe is the chance that JC Penney shares will of their own trading add $2.93 to its current share price. How likely is it that shares will gain 33.5%? There may be company specific challenges, as well as broader economic challenges to consider. But there is also that thought that this could be the year to atone for past performance. Redemption, after all, isn’t limited to Hewlett Packard.

If you believe that may happen within your lifetime or an acceptable portion of that lifetime, you may decide to forego the certainty of a short term tax credit.

Similar considerations may be applied to shares of Petrobras (PBR) and Mosaic (MOS), both of which I’m considering selling for their tax benefits. However, as compared to JC Penney, the hurdle for price recovery to match the tax benefit is quite a bit lower, at 18.5% and 11.7%, respectively. 

Of course, if you’re right, even at that new higher price you can still qualify for a tax loss, however, you may find yourself looking at a much lower credit, if the short term loss becomes a long term loss. As Clint Eastwood might have said, “are you feeling lucky?” If you can grab some option premiums along the way you can help to make your own luck, but whatever the outcome, it is also deferred by a year to 2015, which itself may entail further opportunity costs.

Then again, just look at last year’s losers. Unlikely as it may have seemed at the time, recovery wasn’t outside the realm of possibility.



Bottom line? Ask your tax advisor, but do so soon.

 

Addendum:  An additional factor that I utilize in determining which losing positions to sell is related to another rule that I follow. That is the rule to not hold more than three individual lots of a specific stock. There is no hard science to that rule, but it is related to the desire to not have a specific stock be over-represented in the portfolio.

Occasionally, I will elect to sell a second or third lot of a specific stock because I believe there is greater opportunity for picking up replacement lots at lower prices (after the 30 day period required by the Wash Sales Rule has passed) and selling calls at the lower strikes, than there is in waiting for shares to rebound. In such cases I hope that the cumulative tax benefit and recurring option premiums on lower priced shares will be greater than the benefit derived from continuing to hold original shares.

That is why I included Mosaic and Petrobras shares in the illustrative table. However, individuals should look at their own annual profits and see which of their holdings may allow them the greatest certainty for benefit if sold for a loss, as compared to their own expectations for share price recovery. While JC Penney may be a strategic tax loss for one, it may not be so for another.

This year I will not make official “Tax Loss” sales recommendations, in recognition of the fact that some subscribers also have positions inside of tax deferred accounts. Additionally, as opposed to the past, I will continue, therefore, to follow those positions and track their performance.

Dec182013

Turn DRIP Into Flow with PRIP

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(A version of this article appeared in TheStreet.com)

The idea of utilizing a DRIP strategy toward achieving asset growth is an appealing one. Dividend Re-investment Plans offer the opportunity to take an income stream and convert it into more shares without cost. For the inveterate buy and hold investor the appeal may be compounded by the thought of actual compounding.

For most investors, at least those of moderate means, that would mean adding fractional shares and certainly odd lot shares. It might also mean adding shares in a company at a time that you wouldn’t ordinarily want to be adding shares of that particular company. Regardless of those advocating a dollar cost averaging approach, it would take a large portfolio of dividend paying stocks with payment dates broadly distributed to achieve a sufficient sampling of the market’s ups and downs to really cost average. Otherwise one is at the mercy of timing if dividend dates are clustered on a quarterly basis.

Using the 2013 S&P 500 average for dividend yields that also means a quarterly income stream of approximately 0.5% per eligible position. For example, anyone re-investing quarterly dividends on 1000 shares of Microsoft (MSFT), which offers a dividend yield nearly 51.7% higher than the S&P 500 average, would be able to add approximately 7.6 shares.

While there is certainly a body of evidence that suggests the out-performance of dividend paying stocks, I have never fully understood the allure of dividends. The opportunity to pay taxes in exchange for the privilege of being able to reduce your stock’s cost basis may be an apt summary of the transaction. But for many the dividend represents a tangible expression of ownership and sharing of good fortune. What better way to reciprocate that good fortune than by re-investing the dividend for even more shares?

However, quarterly distributions, small distributions, and being held hostage by timing of dividend payments conspire to make the DRIP strategy inefficient for those interested in compounded growth, or for those that don’t have the patience to wait many years.

While Albert Einstein purportedly referred to compounding as the greatest of inventions, he would have added some additional superlatives had he known about the use of premiums derived from option sales to fuel share purchases and asset growth.

Rather than relying on the muted power of dividends, selling options, on core holdings, such as Microsoft can return a nice weekly, monthly or yearly premium and can form the basis for anyone to design their own “Premium Reinvestment Plan (PRIP).”

In general, I prefer the use of weekly options, but that may require more maintenance and attention than many individual investors are willing to dedicate. However, as an example, anyone purchasing 1000 shares of Microsoft at Friday’s close of $36.69 could have sold 10 weekly contracts at a $37 strike price for $490. Compare that to the $280 quarterly dividend. Of course the shares may be assigned or the contract may expire, allowing the holder to look for additional opportunities to sell new contracts, perhaps even holding shares at the time of the ex-dividend date and doubly reaping rewards.

While the option premium income can’t be re-invested in additional shares at no cost, what it can do is serve as a building block for additional share purchases in any position desired, not just the income producing stock. Furthermore, that purchase of new or additional shares can be done at a time that seems most propitious, rather than being on a pre-determined date. The cumulative impact of selling option contracts on portfolio holdings can be to generate enough income to purchase entirely new positions and in sufficient quantity to have their own income producing option contracts sold.

Income producing income.

If you’re a buy and hold kind of an investor and don’t really like the idea of being subject to assignment on a short term basis then look at the longer term option contracts. The beauty of the derivatives market is that there is no shortage of time frames nor of strike levels available for the investor that wants to customize risk and reward, as well as the time frame in which to invite exposure..

An option contract expiring January 18, 2014, also with a $37 strike price affords a premium of $1120, in addition to possible gains on shares if assigned. To put that into perspective, the premium yield of 3.0% for a 5 week period would be sufficient to re-purchase 30.5 shares of Microsoft. As with the weekly contract, if not assigned the opportunity to do the same is explored in an effort to generate even more income.

For those that can’t be bothered by even monthly contracts or that may want to emphasize share gains over income, consider the sale of a longer term contract, or LEAP, such as one expiring in January 2015. Not only will your $40 strike option contract sales generate an immediate receipt of $2150 in option premiums, but as the holder of shares, unless Microsoft rallies well past $40 prior to expiration you will also receive deferred income in the form of $1120 in dividends. In this instance if shares are assigned the ROI is 19.8%. If not assigned, the total income yield would be 8.9%., regardless of disposition of shares.

I know that “PRIP” doesn’t really sound appealing when said aloud, but investors can get over the unfortunate acronym once the fun starts and the Einstein inside begins to show.