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Making Year-End Tax Moves? Look at These Stocks

Jason Stipp

Note: Pat Dorsey is the former director of equity research at Morningstar. He is now the president of Sanibel Captiva Investment Advisers.

Jason Stipp: I'm Jason Stipp for Morningstar. The year end has long meant maneuvering time for investors as they take a closer look at their portfolio and consider their tax situation. Pat Dorsey is joining me today. He is from Sanibel Captiva Investment Advisers. He has a few ideas for those folks who might be looking to make some maneuvers and possibly gain a little bit of tax benefit.

Thanks for joining me, Pat.

Pat Dorsey: Any time, Jason.

Stipp: So we know that there is a concept of tax-loss selling. We know that investors are trying to match some of their gains with some of their losses and might want to make some changes in their portfolio anyway. As you are looking across the investment universe, you have a few ideas that investors might want on their radars. Let's kick it off and tell me what's the first one you are thinking about?

Dorsey: The first thing, just big picture is, don't let the tax tail wag the investment dog. I don't know how many times I've seen investors make decisions that are smart on a tax basis, but stupid on an investment basis. People might say, "I'll sell this now so that I can buy it back in 30 days, take the tax loss and then buy it back, so it's not a wash sale." Well, if it goes up 15% at that time, that's probably a pretty bad idea. So this is something of which to be careful.

So there are two kinds of moves we've really been making at Sanibel Captiva during the past couple of months just on tax basis. One is that a lot of our clients have sort of a lot of embedded losses, loss carryforwards in the past few years; mutual funds do too, so this is not an uncommon thing. We're using that as an opportunity to move out of securities that have appreciated a lot in a tax-sensitive manner. So take Costco for example. We've owned Costco for the past few years, and it's done very, very well for us. But I would argue at 20 times earnings right now, there's a lot of good news priced into the firm's shares. So that's one that's we've been trimming.

Another move is simply looking for securities where the fundamental story has changed, and so you have the opportunity to move into something else and upgrade your portfolio. Medtronic, for example, is a name that we've really been scaling back on recently. The shares have not performed well during the past three years, but really the bigger story is just the firm's competitive situation is not what it used to be. Frankly, health-care stocks in general are pretty cheap, and there are just better opportunities out there.

Stipp: So another thing that investors might want to be thinking about this time of year, as they're looking at their tax situation, is reducing their tax hassle. You actually have an investment idea, where they might be able to get some income and also potentially simplify their taxes. This is something that isn't very common overall in this space. What's that idea for us?

Dorsey: This is a company that owns pipelines, but doesn't have the tax hassles, such as the K-1s that are associated with owning a master limited partnership, something I know that we talked a lot about when I was still at Morningstar and I'm sure it's still important to people. The MLPs that own pipelines give you some tax advantages, but sometimes these K-1 filings can just be a little bit too much hassle for somebody. There's a company called Kinder Morgan Inc., ticker is KMI, that is structured as a what's called a what's called a C corporation, just kind of a plain-vanilla company. So there's no K-1s associated with it, but it owns KMP, Kinder Morgan Partners, which owns pipelines across the U.S.

So essentially, you get the benefit of the great economics of pipelines. It’s kind of toll-bridge-like economics with automatic rate hikes in many cases every year, without some of the tax complexity in this case. It’s yielding about 3.9%-4.0% and because of the recent purchase KMI did, it looks like the firm is going to be able raise that dividend at a pretty high rate, probably in the high single digits during the next several years.

So, certainly if you are an income investor, and you need an investment for a tax-qualified account--so you can't own MLPs in an IRA or 401(k) [Note: Although you can hold MLPs in such accounts, it would not be ideal. Please see this article for more information]--you should look at Kinder Morgan Inc, KMI. We think it is one of the more attractive opportunities we’ve seen in a while because of a 4% yield in addition to a high-single-digit increase in that distribution. That’s a nice total return in today’s environment.

Stipp: Certainly, an interesting one for investors to take a look at. Investors also are looking to put some other money to work. Maybe they did some tax-loss selling or they have some funds or some cash in their accounts, and they want to try to deploy it. Do you have any other recommendations for them there?

Dorsey: So there’s few places you can look right now, kind of getting not so much off the beaten path. BlackRock is one that we’ve been buying a little bit of recently, One of the world’s largest asset managers, the firm started out of the bond shop of course and then bought Merrill Lynch’s active equity business in about 2005 or 2006. And then the firm bought during the big credit crunch Barclays Global Investors, which is a massive passive business, and also iShares, which of course is growing incredibly quickly as most exchange-traded fund providers are.

What I like most about BlackRock, aside from just sort of a general good stewardship of investor assets, is the firm has really done a great job returning cash to shareholders. The yield is still around 3.2%. The firm has raised that dividend at a very fast clip during the past few years. BlackRock's portfolios are balanced about 50-50 between equity and fixed income assets under management, so it’s very balanced both ways. And you know what, most retail investors don’t know BlackRock. So, even though the firm is one of the world’s largest asset managers, arguably there’s an opportunity for it in the retail channel to increase some market share. So that’s an idea that it’s going to be a little volatile because, of course, asset managers bounce up and down with the market. But certainly the economics are very, very good, and at about 12-13 times earnings, you are getting business with truly phenomenal economics, a good dividend that’s rising at a decent rate, and I would argue some good tailwinds behind it.

Stipp: Pat, those are some great ideas for investors, as they are doing their year-end planning and looking forward to 2012. Thanks for joining me today.

Dorsey: Thanks, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.