Want to Lower Your Tax Bill? Don't Ditch Underperformers

Sometimes you have a theory that sounds like a winner, until you test it. I’ll tell you right off the bat: This is one of those times. With about six weeks left in the year, investors are now starting to think about tax optimization.

It’s common practice for investors to sell off their losing positions to offset the gains from their winners, thereby lowering their tax bill. This led me to the idea that stocks that have been beaten down would face increased selling pressure in the final weeks of the year and therefore underperform. Let’s see what the data shows. 

Do Beaten Down Stocks Lag? 

Going back to 2022, I grouped stocks by their year-to-date return as of Nov. 17 of each year (because that’s the day I did the study in the current year), then I summarized the rest-of-year stock returns for each group. As a reminder, my theory was that the stocks that were beaten down the most would underperform, due to investors selling off their losers near the end of the year for tax purposes.

The initial data seems to support my theory. Stocks that were down 25% or more as of mid-November were the only group that, on average, went lower for the rest of year, with just 46% of those returns positive. The stocks that outperformed the most through mid-November (up 10% or more) were the next worst group, averaging a return of 0.74%, with less than half of their returns positive.

Looking at the percentage of stocks beating the S&P 500 Index (SPX) for the rest of the year, this 10%+ group was by far the worst, with just 40% of the stocks beating the SPX.

While the table above supports my theory, I wanted to see how these groups would have fared last year. It was a bad end to the year, with all stocks averaging a loss of 2.8% (the SPX itself was about breakeven). The stocks that had been beaten down the most as of mid-November outperformed, however, averaging a return of about 3.4%. In fact, 44% of the stocks in the beaten down group were positive, compared to just 28% of all stocks. 

I found that 2023 also went against my theory. The most beaten stocks through mid-November of 2023 outperformed for the rest of the year. Of the three years I analyzed, only 2022 showed beaten down stocks underperforming. That year had the highest number of stocks down at least 25% by that point. That's why the overall figures supported my theory, even though the last two years showed the opposite.

I decided to look at it one more way. For this next table, I grouped stocks by where they were compared to the last two years. I used their two-year high as 100% and the two-year low as 0%, and found where the stock ranked as of mid-November. Again, I summarized the rest-of-year returns for each group.

My theory would be that stocks closer to their low would underperform for the rest of the year. As you can see, that’s exactly the opposite of what occurred. The stocks flirting with their two-year low gained 4% for the rest of the year, with 59% of them beating the SPX. Again, when I look at it for each of the last three years, 2022 would have supported my theory that beaten down stocks underperform. Over the past two years, however, the beaten down stocks have crushed all the other groups.

Below is a list of 30 stocks that have been beaten down by the criteria I used above (down 15% year-to-date and near their two-year low). The theory I put forth at the beginning of the article would say avoid these stocks, but the data shows bullish implications over the past couple of years. Numbers don’t lie.