Calton – and (Keep Reading) a Few Words about Index Funds

A couple of weeks ago I updated you on Calton (CN), on which we had a five- or tenfold gain the first time around (much of it based on the recent market lunacy, but still) . . . and on which we seem to be making a much more modest, but respectable, gain since I suggested you consider it at $4.25 last July 24.Friday, the company announced a $5 dividend, payable July 5th. Apparently, for tax purposes, it will be considered a ‘return of capital’ – i.e., a partial liquidation of the company, not a distribution of profits – which means that if you did buy some at $4.25, only the extra 75 cents should be subject to tax.

The stock closed Friday at $5.94, meaning that, at that moment, the market was valuing what would remain of the company at 94 cents. Actually, in fact, it may be worth a little more. (But even at $5.94, you’re up 39% in under a year.)

So far as I know, once the $5 is distributed, three assets will remain:

about $2 a share in cash, which I would value at about $2 (cash may not be exciting, but it’s wonderfully easy to value);

an interest in some Internet start-ups, which could one day be worth something, but which could also wind up burning through the company’s $2 a share of cash;

and the value of a “public shell,” which might be fifty cents or a dollar more. (Private companies sometimes “go public” by acquiring a company that’s already public. Calton, because it’s already listed on the American Stock Exchange, and because it has little by way of operations or employees to mess it up – no toxic waste hazards likely to be discovered – would seem to fill the bill nicely, if Calton’s management, which controls a majority of the stock, ever wanted to retire and capitalize on this “asset.”)

So once the $5 is distributed, my guess is that the stock – which will instantly drop by $5 in value – should trade at closer to $2 than 94 cents. Not to say that it will, but that, in my view, it should. We’ll see. There is the real risk that it will burn through its cash and wither away, worthless. But there is also the possibility that management, which has a much bigger stake in this than you or I, will work in its own self-interest to make the assets grow.

Incidentally, the dividend is “payable to shareholders of record as of June 20.” That means the stock should be trading at least a little above $5, as it is now, until June 20. But that on June 21 it will be instantly worth $5 less, and will open approximately $5 lower than it closed the night before. Anyone who owned the stock on June 20 (even if they then sold it) would get the $5 dividend July 5 (or whenever it actually hit their brokerage account).

I’d be surprised if, once the cash is distributed, the stock did trade as low as 94 cents – not that I haven’t been wrong many times before. I’m going to try to buy some under $6 in the meantime, figuring that in a month or so, assuming no unforeseen snags, my actual cost will have been under $1, and that – who knows – there might still be a little value to be realized here. Like that last little dab of toothpaste most people waste. Not to mention all the wonderful ketchup that’s still sticking to the sides of the container when it’s thrown out. It pains me!

Incidentally: most of you know that my advice is to avoid playing the stock market, and generally to put most or all the money you have earmarked for stocks into one or two no-load, low-expense, index funds. And to engage in a lifelong program of steady, periodic investing in these funds.

So why the occasional discussions of specific stocks in this space? And why do I buy a stock like Calton?

A few reasons.

First, index funds are boring. Life is not a business, as my dad used to say . . . so if, presuming you can afford the risk – which if you still pay interest on your credit cards or have a car loan you can’t – why not? Live life on the edge. Has there ever been anything more exciting than watching Calton, day after day, trade at $4.25 or $4.50, hoping that one day – one glorious fireworks of a day – it could hit $5? Tell me you haven’t been goosebumps since last July 24, if you bought the stock. Tell me you didn’t hate weekends, because on weekends the excitement was suspended.

Excitement like this is hard to match. And part of me secretly believes that if I’m relentlessly logical and patient enough, and look in odd enough nooks and crannies for value, I might actually beat the market. (Most of me remains appropriately unimpressed.)

Second, I’ve been nervous about the general level of stocks over the last few years, and so have tried to find specific ones, some of them ridiculous or tiny, like Calton, that had not been swept up in the general exuberance. Today, that looks smart, but with hindsight, it may well look stupid, because “timing the market” is generally a losing game and not something I have much confidence that I or almost anyone else can do. A slow-but-steady, dollar-cost-averaging approach probably makes more sense. But – back to point #1 – I enjoy the game.

Third, from a tax standpoint, it actually makes sense to have a little speculative fun with some of your money, so long as you can afford the risk. Most of it should be someplace sensible, like index funds for your stocks and Treasury Direct or a money market fund for your safer money. But index funds – while exposing you to blessedly little tax – don’t give you that extra little tax oomph you can get, at least up to a point, when you invest directly.

Say you put $2,500 each into four somewhat risky but interesting stocks. I’m not talking about crazy stuff you have no clue why you’re buying – that’s always stupid – I’m talking about stocks like Calton or stocks in well-known companies that have encountered bumps, yet could recover (look how nicely Boeing has done, up from 38 to 65 in under a year), but that might also fall further and further into decline (poor Polaroid!).

The simple tax trick here – or at least the first half of it – is to sell your losers in order to deduct up to $3,000 a year against your ordinary income (even if you don’t itemize deductions). If you are in the 33% tax bracket, between federal and local income tax, that cuts your tax bill by $1,000.

(And then if you like – having waited 31 days to avoid Uncle Sam’s “wash sale” rule that would invalidate the tax loss – you could just buy the same stock back, figuring that if it seemed a good buy at 20, it might be an even better buy here at 6. There is no larger economic purpose served by search a maneuver – it will not grow the economy or help build a new factory or invent a new vaccine – but it will lower your taxes.)

And then the other half of it is that with the stocks that do go up instead of down, you either hold on and let them grow, untaxed, until you eventually do sell at the low capital-gains tax rate . . . or else you use those winners (so long as you’ve held them at least a year and a day) to fund your charitable giving, and escape tax on the gain altogether.

(For those fortunate enough to be in a position to give away thousands of dollars a year rather than a couple of hundred, the smart thing to do is to give appreciated securities rather than cash. And the smart way to do that is by setting up an account with Fidelity’s pioneering Charitable Gift Fund, or Schwab’s excellent knock-off of the same thing, or a local community foundation. I do mine partly through Fidelity and partly, to support my community, through the Stonewall Community Foundation.)

By contrast, within an index fund, you might have one stock up 300% and another down 90%. But all those winners and losers largely average out, and you have no way to use the big loser to reduce your income tax or the big winner to fund your college reunion gift.

This issue of “tax control” is one of the main appeals of FolioFN, which lets you, in effect, control your own small index fund.

I feel like Matthew Broderick at the end of Ferris Bueller’s Day Off. You mean you’re still reading this endless column? Go home!

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