Tax-Season Losers Could Be Sleepers

While tax-loss selling can put pressure on stocks at year-end, it can also create some interesting opportunities for nimble investors.

As 2003 draws to a close, investors will likely dump stocks that have underperformed, in an attempt to offset any capital gains, decreasing their overall tax burden. But buying this group of stocks on Dec. 31 has the potential to yield "meaningful gains," according to Smith Barney analyst Albert Richards.

Richards screened for small-, mid- and large-cap stocks that had declined sharply from Jan. 1 to Dec 1. While he expects these issues to decline further throughout December, he believes they could perform well as the selling pressure abates at the start of January.

Companies that have done so poorly as to be omitted from the Russell 3000 index have historically provided "fertile hunting ground for year-end opportunities," he said, adding that this group of underperformers has produced solid gains relative to the index in every year except one since 1990.

Richards singled out Allos Therapeutics(ALTH Quote), which has fallen 61% this year; Private Media Group (PRVT Quote), down 36%; Gaiam Inc(GAIA Quote), off by almost 45%; and On Assignment(ASGN Quote), which has shed 35%. All of these firms have market caps of at least $75 million and were dropped from the Russell at the end of June.

"Those companies with the largest share-price declines have the greatest amount of tax-loss selling, as well as the largest January bounces," he noted.

Richards also suggested that LaBranche(LAB Quote), Winn-Dixie (WIN Quote) and Vertex Pharmaceuticals (VRTX Quote) could be in for a rebound next month. LaBranche has fallen 62% this year, while Winn-Dixie is down 40% and Vertex is off 43%.

Among large-cap companies, he pointed to Eastman Kodak(EK Quote) and Qwest Communications(Q Quote), which are both down 30% for the year, as well as Newell Rubbermaid(NWL Quote), which has declined 25%.

Although tax-loss selling has provided some great buying opportunities in the past, Richards notes that the opportunity this year has been diminished somewhat, because only 245 of the 2,000 companies in the Russell 2000 index are actually down year to date. Just 102 companies in the Russell 1000 mid- and large-cap index are in the red for the year.

"As a result, there are fewer tax-loss opportunities for investors to realize," Richards said. "The counter to this, of course, is that we are, in our opinion, likely to see a somewhat exaggerated effect."