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Don't rely on predictions - Be disciplined with your stocks

Tuesday, September 9th, 2014

The buzz on Wall Street lately is about corporate inversions -- when U.S.-based companies merge with foreign companies to take advantage of lower corporate taxes.

The United States has the highest corporate tax rate of all major countries at 35 percent. Some corporations have moved their headquarters to Ireland, which has a 12.5 percent corporate tax rate.

I think much of this could be averted if the government would allow corporations to bring their overseas dollars here to the United States. Many companies are sitting on billions of dollars that they have paid some tax on. If they bring that business to the United States, they will pay the corporate tax rate of 35 percent on what they earned in another country. That money then could be used for expansion and capital investment, which would help create more jobs.

While inversions are positive for the corporation, anyone who does not hold the shares in a qualified account, such as an IRA, will experience a tax consequence such as a capital gain. There is no way to prevent this.

Also, employees who hold stock in the company that is undergoing an inversion may have to file Form 8938 with their taxes if their stock holding exceeds $50,000 on the last day of the year, or if the value was more than $75,000 during the tax year. These limits are for singles or married people filing separately.

If you are married and filing a joint return, Form 8938 must be filed if the value exceeds $100,000 on the last day of the year or when any time during the tax year the stock value exceeded $150,000.

Managing investments still can be a humbling experience even after doing this for more than 30 years. Investors have to realize that they will not be right all the time; however, I believe it is better to be cautious than to try to squeeze out every last penny of a gain.

Let me give you a real-life example: the first buy that I did on Alcoa in October 2006. Based on the fundamentals, I purchased Alcoa at $26.60 per share and by Feb. 13, 2007, the stock had reached its target sell price of $35 for approximately a 32 percent gain.

Let me also point out that it is not normal to have a 32 percent gain in such a short period -- do not expect this when you are investing in companies. You are setting yourself up for failure if you think you can obtain these types of gains on a regular basis.

I became interested in Alcoa once again in April 2012 and began buying shares at $9.82. At this point, the mean estimate of the analysts’ forward earnings per share was 96 cents, which would yield a target sell price of $15.84 for potential 61 percent gain.

From April 2012 to Sept. 16, 2013, the forward earnings declined from 96 cents per share to 50 cents per share. This caused the target sell price to fall to $8.25 -- not the direction I would like to see it go. While I believed the mean estimate of 50 cents per share was far too low compared with what I was reading about the company, I still had to stick to my discipline and sell the stock at the current computed target sell price.

Fast forward to today and you will see the analysts’ mean estimate for December 2015 at 87 cents per share. This would yield a target sell price of $14.36 per share, which is below the current price of about $16.50 per share.

It should also be noted that in the last 90 days, the earnings-per-share estimate for the year ending December 2015 has risen from 66 cents to 87 cents per share. Many novice investors would look at this and say “Oh my gosh, I made a mistake,” but that is not the case at all.

What is important to understand -- and why I wrote about my experiences of buying Alcoa -- is that predicting the future can be hard. It can change and there is nothing you can do about it.

It is important to remember to stick with a discipline of investing based on the fundamentals at low prices and sell those companies when the risk becomes higher as valuation ratios increase. I’ve explained to clients that I am probably wrong a third of the time, but being right two-thirds of the time and sticking to a good discipline of buying companies low and selling them high based on the fundamentals has yielded some decent returns for investors.

In addition to the decent returns, it has also helped reduce the emotional roller coaster that forces investors to give up on stocks, thus going without future potential gains.

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