MSNs take on this year's Jan Effect:
moneycentral.msn.com
Some stocks dip at year-end because of tax-loss selling, only to bounce back in January. Here are 15 that could benefit from this 'January effect' next month, and a screen to find more.
By Harry Domash
'Tis the season when you should consider dumping your losers so you can take the tax write-offs. Of course, that's not a novel idea, and millions of investors are undoubtedly doing just that.
Here's the good news: All that tax selling creates potential buying opportunities.
For many investors, when it comes to making year-end tax-selling decisions, reducing taxes is more important than a stock's fundamental outlook. Many will sell a stock even if they think it has great prospects. They figure that they can buy it back 31 days later with no penalty.
In fact, some market experts point to tax-loss selling as the reason for the "January effect," which, in theory, is the tendency of stocks, especially small-caps, to move up in January. However, the January effect is a controversial topic. Research shows mixed results. Some years it works, some years it doesn't.
January effect or no, there is no doubt that tax-loss selling happens, and in many cases, worthwhile stocks are thrown out with the bathwater.
The trick, of course, is pinpointing those worthwhile stocks without getting wet.
Around this time last year, I devised a screen using MSN Money's Stock Screener for finding stocks that, because they had dropped significantly during the year, were tax-loss selling candidates, but were also candidates for a January snapback because they were also fundamentally sound. My intention was to find stocks likely to achieve a short-term pop, not long-term buy and hold candidates.
Last year's model
I limited the field to small-cap stocks (under $1 million market cap) because, according to the pros, the January effect is more pronounced for small companies.
They reason that it's mostly individual investors who do tax-loss selling, and their selling has a bigger impact on small, thinly traded stocks than on big companies with millions of shares changing hands daily.
Within the small-cap category, I looked for stocks that were down significantly for the year. From that group, I then picked financially strong firms with strong earnings-growth expectations from analysts.
My results were reasonably successful, but with a surprise. It turned out that January 2005 was a bummer for the market, and the January effect didn't appear as scheduled. Instead, it happened in February. By March 1, the stocks in my portfolio had gained 6%, on average, from the start of the year. By contrast, the Russell 2000 index ($RUT.X), which gauges the action of small stocks, dropped 2% during the same period.
This year's improved version
Since last year's results were hardly earthshaking, I decided to rethink my strategy. For starters, I wondered, why was I screening for small caps?
The premise of the January effect is that it's caused by individual investors selling lightly traded stocks. So, to me, at least, it makes more sense to cut to the chase and limit the candidate list to stocks with low daily trading volumes. What's low?
Most widely followed stocks trade millions of shares daily. For instance, Cisco Systems (CSCO, news, msgs) trades around 39 million shares a day, on average. I arbitrarily set my limit at 200,000 shares, but there's nothing magic about that number. You can raise or lower the number if your screen turns up too few or too many stocks.
In theory, for this strategy, the lower the daily trading volume the better. But there's such a thing as too low. A stock trading only a few thousand shares daily can be easily manipulated, which adds risk.
I established a 20,000-share minimum trading volume to avoid that pitfall. I don't suggest lowering that minimum much, certainly not below 10,000 shares.
Also, a very low share price can be a problem. In my experience, stocks trading below $10 or so per share are risky business. So I set my minimum acceptable trading price at $10.
Screening Parameter: Average Volume. Last Quarter <= 200,000>
Screening Parameter: Average Volume. Last Quarter >= 20,000
Screening Parameter: Last Price >= 10
When I checked, slightly more than 1,200 stocks met those requirements.
The losers
The next step is to find the stocks that are tax-loss selling candidates because they lost money for their shareholders during the year.
Last year I looked for stocks that had dropped between 25% and 80%. This year, I modified that range slightly to losses of 20% to 75%. I figured that stocks that had dropped 80% might be a little too risky, and investors with a 20% loss would be just as motivated as those with a 25% loss to take a tax write-off.
Screening Parameter: % Price Change YTD <= -20>
Screening Parameter: % Price Change YTD >= -75
Adding those requirements cut my list down to 129 stocks.
Rebounding ability
The final step is to pick the stocks with the best chances of bouncing back. Last year I used a combination of fundamental factors such as debt levels, along with analysts' earnings forecasts, to make that determination.
But, in retrospect, fundamentals don't mean much if you're only planning on holding a stock for a couple of months. So this year I changed my strategy to rely solely on the analyst opinions. After all, their forecasts and recommendations drive share prices in the short-term.
I start with analysts' buy/sell recommendations. MSN divides analyst recommendations into five categories: "strong buy," "moderate buy," "hold," "moderate sell," and "strong sell." I only want stocks that analysts are advising buying, so I limit the field to stocks with "buy" or "strong buy" ratings.
Screening Parameter: Mean Recommendation >= Moderate Buy
Because expected earnings growth generally drives share prices, it makes sense to limit the field to stocks with strong earnings-growth expectations. Generally, 15% forecast annual earnings growth qualifies a stock as a growth candidate.
Thus, I require at least 15% annual earnings growth for the 2006 fiscal year as well as 15% average annual earnings growth for the next five years.
Screening Parameter: EPS Growth Next Yr >= 15
Screening Parameter: EPS Growth Next 5-Yr >= 15
My January bounce screen turned up 15 candidates. They all either stumbled last year or are in out-of-favor industries. However, analysts are expecting a recovery.
This screen is only useful if run in November or December. Its purpose is to pinpoint stocks that are likely to pop in January, or in February at the latest. It doesn't assess long-term prospects.
January snapback candidates
Company name Industry name *Recent price
America's Car-Mart (CRMT, news, msgs) Auto Dealerships $17.00
Celebrate Express (BDAY, news, msgs) Catalog & Mail Order Houses $14.09
Comstock Homebuilding (CHCI, news, msgs) Residential Construction $14.27
Digi International (DGII, news, msgs) Networking & Communication Devices $11.95
Encore Capital Group (ECPG, news, msgs) Credit Services $17.46
Levitt (LEV, news, msgs) Property Management $22.95
Ness Technologies (NSTC, news, msgs) Information Technology Services $10.62
Possis Medical (POSS, news, msgs) Medical Appliances & Equipment $10.02
Primus Guaranty (PRS, news, msgs) Credit Services $10.89
Radio Onc (ROIA, news, msgs) Broadcasting - Radio $10.78
Radware (RDWR, news, msgs) Information Technology Services $18.98
Rocky Shoes & Boots (RCKY, news, msgs) Textile - Apparel Footwear & Accessories $22.99
The Sands Regent (SNDS, news, msgs) Resorts & Casinos $10.05
StarTek (SRT, news, msgs) Staffing & Outsourcing Services $17.41
X-Rite (XRIT, news, msgs) Photographic Equipment & Supplies $10.60
*Data as of Dec. 13, 2005.
Because I've revised the screen considerably, I don't know if it will work better or worse than last year's version. So, its best use might be to create a watch list. Then, if it produces good results, use real money next December.
At the time of publication Harry Domash did not own or control shares in any of the stocks mentioned in this article. |
