PPK Value, page-315

How to capitalise on tax loss selling in small caps

As we approach the end of the financial year, it is common to see heightened trading activity in many shares as investors try to optimise their tax liabilities by crystallising losses to offset gains. Additionally, the new financial year provides a general impetus to “clean up” portfolios (similar to my resolution to hit the gym every new year!)This heightened trading activity can increase the chance of dislocations between share prices and underlying business intrinsic value, as the selling can be irrational and not tied to fundamental performance. This creates opportunities for investors willing to take advantage of that irrationality and take a longer-term view for investing. Given the short time frame in which these opportunities may exist (generally the last couple of weeks of June), it is worth investors preparing ahead and putting together a list of candidates who fit the bill for tax loss selling and keeping some cash ready to take advantage if it emerges. Some general characteristics to look for include:
FOLLOW Poor share price performance: As the name implies, tax loss selling requires an investor taking a loss on a share when they sell, and this is most easily found in shares that have performed poorly throughout the financial year. A good place to start identifying opportunities here is simply looking at shares currently trading near their 52-week lows as provided by Market Index here. Stable or recovering business performance: It is worth remembering that most shares that perform poorly deserve to, as the underlying business has performed poorly also. To take advantage of tax loss selling, it is important to find the divergence between the share price and the business, so identifying those businesses whose operations are stabilising or turning around is important. Sector-specific weakness: When an entire sector faces challenges, investors will often use the catalyst of the end of the financial year to exit any shares in that sector, regardless of whether individual businesses are being impacted. Retailers could be an example of this, given the clouds overhanging consumer sentiment.
Low liquidity: In general, low liquidity shares tend to have more pronounced price movements, meaning the incremental tax loss selling can mean a larger decline in price. Liquid shares can more easily absorb the impact of tax loss selling and not lead to any meaningful share price movements away from the business's intrinsic value.