Apple Inc. (NASDAQ:AAPL) shares are on the fritz again, as investors wait to hear the company’s latest quarterly earnings report. Traders who think that now is the time to give on the stock’s growth have something else to worry about, the coming changes in capital gains tax. David Winograd at Macobserver.com wrote an excellent article on that exact subject earlier today.
Apple Inc. (NASDAQ:AAPL) share price has collapsed recently, as investors wait for the company’s expected launch of the iPad mini. The company may not sell as many iPhone 5s as had been expected, and the backlash after the coming earnings report seems to have the market spooked.
Next year the Bush era tax cuts are expected to expire. There is also a premium of 3.8% being applied to long term capital gains rates, if the new Medicare plan is implemented as expected. With investors questioning the growth prospects of Apple Inc. (NASDAQ:AAPL) shares, now is the time to consider the tax implications.
The current long term capital gains tax, for assets held for more than a year, is 15%. With the expiry of the tax cuts, that number will increase to 20%. The added Medicare premium brings that number up to 3.8%. This does not take into account State capital gains or other charges, but let’s keep things simple.
Because Apple Inc. (NASDAQ:AAPL) shares have multiplied so many times in recent years, the capital gains bite of any sale is more of a worry with these shares, than with most others. Winograd gives an excellent example.
If an investor made the risky decision to buy Apple shares in 1996, when the company looked about to fail, they would have paid $600 for one hundred shares. Those shares split twice in that time leaving him with 400 shares in the company.
Today, at a price of $641, those shares would be worth $256,400, not a bad return. Having paid $600 for the shares initially, he is left with a gross profit of $255,800. Now the Internal Revenue Service wants their piece of the action.
At the current rate of 15% our illustrious investor will owe the tax man $255,800*0.15=$38,370. Sure that’s a whopping bill, but it leaves him with $217,430. Next year, if the increases in capital gains come about as expected, things will be very different.
For this example we assume share prices are the same in both years. For those more discerning, we’ll have a look at the effect of share prices on the math in a moment.
If he chooses to wait, our unknown hero will be liable for capital gains taxes at 23.8%. The math works out like this, $255,800*0.238=$60880.40 This leaves him with the very respectable sum of $194,919.60. By not selling this year, our investor has effectively lost $22,000.
How much will the company’s shares need to increase to cancel out the effect of the increase in capital gains tax? In order to get a return of $217,430 at rates of 23.8%:
(Skip the next bit if math isn’t your thing.)
X-(X*0.238) = $217,430
0.762X = $217,430
X = $285,341.21
Total Net Profit Per Share = $285,341.21/400=$713.35
Total Expected Share Price = $713.35+6=$719.35
If you skipped the math, it tells us that Apple shares would need to reach $719.35 next year in order to cancel out the effect of capital gains taxes increases. That offers no return for the time you spent waiting for the firm’s shares to increase to that level. That’s a premium of over 12% on the equity’s current price.
Apple Inc. (NASDAQ:AAPL) shares have brushed up against that number, and recently, when shares reached $705 in September. However, capital gains calculations should come into play for anybody who has held the shares for more than a year and is looking to sell.
Apple Inc. (NASDAQ:AAPL), along with every other equity in the United States, is a less attractive investment right now. The new taxes mean there are less returns next year than there is now. There could be some hope remaining.
Like last year, the Republican legislators could try to force the hand of the president to extend the Bush era tax cuts once more. If Romney is elected, he might extend the tax cuts on entering office. The Medicare tax increase could also fall victim to a Romney presidency.
It is difficult to foresee what Romney will do in the White House if elected. He has claimed he will not cut taxes, but anyone old enough to recall George Bush’s presidential campaign will remember the same promises being broken.
Apple investors need to be wary of the capital gains increases. The gains on these shares in the past decade have been truly tremendous, and the taxes on them will be similarly magnificent in size. This is an issue that effects choices right now.
If, however, you believe Apple Inc. (NASDAQ:AAPL) still has a great deal of growth potential, and will quickly drive above $719, it is certainly worth holding. With tax hikes heading straight toward investors, now is the time to reevaluate the growth potential of any long term stocks.
For Anybody Who Wishes To Work Out The Price An Equity Needs To Reach In Order To Cancel Out The Effects Of This Tax Hike:
Here’s The Formula:
Original Purchase Price – Current Price = Gross Profit Per Share
Gross Profit Per Share*Number Of Shares=Gross Profit
Gross Profit*0.15 = Tax This Year
Gross Profit*0.238 = Tax Next Year
Gross Profit*(0.238-0.15) = Tax Premium Next Year
Gross Profit-Tax This Year = Net Profit This Year=(NPY1)
Those are the basic identities. Here’s how to find out the increase needed to satisfy the tax increase:
NPY1/0.762=Net Profit Required
Net Profit Required/Number Of Shares = Net Profit Per Share
Net Profit Per Share+Original share Price = Required 2012 Price.