One investment technique commonly used at year-end is tax-loss swaps. Morningstar has a few suggestions there.
The idea is to sell one stock at a loss, garnering a tax benefit, and buy one in the same industry to replace it.
“First, investors [should] check with their tax advisers,” said Dave Sekera, chief U.S. market strategist for Morningstar. “Taxes are very difficult, and [you must] make sure that you’re not running afoul of any wash-sale rules.”
“A wash sale is a transaction in which an investor sells a security at a loss and purchases ‘a substantially similar one’ 30 days before or 30 days after the sale,” according to Investopedia. In a wash sale, investors can’t claim a tax loss on the stock they sold.
As for deploying the tax-loss swap strategy, Morningstar looks for stocks to sell that have dropped over the last year or two. It also looks for stocks that are overvalued according to its fair value estimates.
“You want to sell those stocks that have capital losses and use that loss to offset the capital gains you may have elsewhere,” Sekera said.
“And then the other part is to reinvest those proceeds in stocks you think are undervalued that have similar characteristics to the stocks that you sold.” That keeps your portfolio with the same balance.
Sekera offered three tax-loss swaps to consider:
Xerox, Salesforce
Sell Xerox (XRX) -) and buy Salesforce (CRM) -).
Xerox: “Over the past 10 years, that stock has dropped at an average annual rate of 8.2%,” Sekera said. “I think the company is a melting ice cube…. There’s really no upside growth trend in earnings.”
Salesforce: Looking at the tech sector, Morningstar analyst Dan Romanoff thinks Salesforce has the best combination of top-line growth potential, potential for operating margin expansion and has a strong balance sheet.
CrowdStrike, Fortinet
Sell CrowdStrike (CRWD) -) and buy Fortinet (FTNT) -).
CrowdStrike: “The stock has fallen an annualized 15.9% over the past two years,” Sekera said. “We’re seeing increased competition from a number of cybersecurity vendors.” They’re expanding into the same area as CrowdStrike.
Fortinet: In cybersecurity, “Fortinet has the best combination of quality and value,” Sekera said.
“The firm stands to benefit [from] secular tailwinds in network security and vendor consolidation,” said Morningstar analyst Malik Ahmed Khan.
American Airlines, Norfolk Southern
Sell American Airlines (AAL) -) and buy Norfolk Southern (NSC) -).
American: Its stock has dropped an annualized 7.8% over the past 10 years. “Airlines have really had a difficult time passing through inflationary cost pressures, higher labor costs and higher oil prices,” Sekera said.
Norfolk Southern: Railroads have cost advantages over other transportation methods, and the railroad sector has efficient scale, Sekera said. Also, “rarely have railroad stocks traded at [this much] of a discount to our fair values.”
