How to capitalise on tax loss selling in small caps (and 3 stock examples)

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:

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.

Some small cap examples

DGL Group (ASX: DGL): Down about 40% this financial year and over 85% from its 2022 peak, DGL certainly ticks our first box of a poor-performing share price. The DGL stands for Dangerous Goods Logistics, which provides a good description of this business that offers a full-service solution for chemical and environmental manufacturing and distribution. Importantly, DGL may also tick our second box, with the last update from the company in March confirming that after a worse-than-expected first half result, second-half trading was seeing a “strong rebound in activity” leading to “stronger revenue and profit performance in the current half.” With CEO/founder Simon Henry owning more than 50% of shares outstanding, DGL is also illiquid and can see large swings in price on relatively little volume.

Articore Group (ASX: ATG): The artist formerly known as Redbubble has performed adequately in FY24, up about 10%. However, zooming out to a longer view shows a share price down nearly 95% from its 2021 peak, meaning there are likely many shareholders sitting on a significant loss who may finally pull the pin as we approach the end of the financial year. However, after some self-imposed strategic missteps, founder Martin Hosking stepped back into the CEO role to turn the business around. The business recently announced a $5m share buyback that “reflects the improvement in our financial position and confidence in the Group’s future performance.”

Camplify Holdings (ASX: CHL): A tough year for this marketplace of caravan and recreational vehicle rentals; some indigestion integrating a large European acquisition and a cautious consumer outlook has seen the share price fall about 40% this financial year and over 70% from its 2021 highs. At a recent investor day, management showed the disruption caused by the integration of their European acquisition has been resolved, with bookings recovering back to normal levels, while the core Camplify business has continued its growth, with third-quarter revenue growing 29% on last year.

Summary

As we enter tax loss selling season, it is important for investors looking to take advantage to be prepared. Build excess cash to deploy and develop a list of potential targets you would be comfortable holding as an investment into the medium/long term, as well as the price you would be happy to pay. Given the illiquidity in some small caps, share price swings can be volatile, and the buying opportunity may only last a day or two, so it is important to be prepared and ready to buy!