How The Fiscal Cliff Could Actually Make Stocks More Valuable

There has been a lot of talk about how raising the tax on dividends and capital gains will end up making people sell their shares.

But I think a different scenario could unfold. First there are a lot of companies issuing special onetime dividend payments to their shareholders before 2013 to avoid extra taxes.

For example, Whole Foods WFM will be issuing a onetime $2 per share dividend before 2013. That's huge! If you bought this stock in 2009, this one time dividend payment would yield you 20%!

This got me to think, how else will they try to save money on taxes if rates rise? Companies may stop raising their dividends and opt to buy back shares instead. The government taxes corporations 35% of their profits, and then if the company pays its shareholders, some of those same profits are taxes again at 15%.

The dividend tax will rise and be taxed as ordinary income if congress does nothing, but it is possible they may make changes before 2013.

Instead of paying that extra tax, companies could just take their profits and buy back shares. This would take shares out of the market. Fewer shares would be available, and we know when there is less of something, that something often becomes more valuable. This is like a back door dividend payment.

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Notice I didn't say share prices will rise. They could, but it's not a guarantee. I said it could make them more valuable. If stock prices remain flat, but there are fewer shares this would represent a better value.

I also still think you should look for dividend income and not be scared off by higher taxes. Dividends will still be better than income tax. You don’t have to pay social security or medicare taxes on dividends!

Now let’s get into the capital gains. If congress (again) does nothing by the end of the year, short-term capital gains is set to increase from 35 percent to 39.6 percent and long-term from 15 percent to 20 percent.

Thanks to high frequency trading, the average stock is only held for just 22 seconds now. Ouch. We can't play that game. The only way for us little guys to win is to pick a market leader that trades at a good price, has a good cash flow, and has a promising future, then let time do the work for us.

A trend to hold stocks long term may come about again. If you are constantly trading any short term profits then your tax is double than if you hold for the long term!

Now, I want to be clear. Over taxing is not good for business. Making a profit is not easy (why do you think there are so many annoying commercials?); it takes a lot of work and added value, throwing lots of taxes on that just make it that much harder to succeed.

Indeed, this is not an easy time to be an investor, but don't let that stop you from trying. If you can do it well now, think how much easier it will be when the next secular bull market comes along!

Pay attention to companies that buy back shares. Corporate insiders are also looking to buy shares, no doubt from finding some value from the fiscal cliff fears.

On the contrarian side, the masses are buying bonds and selling stocks. It's always best to take the opposite of what everyone else is doing.

To recap, it's going to take extra work to find good companies to invest in. I don't know what the direction of the market will be (I'm terrible at calling that), but if a company continues to buy back shares and take them out of the market that will make any shares you own more rare. Don't let the fiscal cliff keep you from investing.

The U.S. is going to face a lot of challenges down the road. Prepare yourself by staying out of debt, owning precious metals, and only buy the best companies at an attractive price.