This seasonal investing strategy is 100% accurate in the past 35 years — here are this year’s stocks to consider buying

Since 1986, in years when the market was down for the year through October, tax-loss-selling candidates beat the S&P 500 SPX, -0.75% 100% of the time during November-January, notes Bank of America. They beat by 8.2 percentage points on average, says the bank.

Otherwise, for all years they outperform 70% of the time, beating the S&P 500 by 1.8 percentage points, says Bank of America in a note written by quant analyst Savita Subramanian. 

One wrinkle: These names can lag a bit in December, the month individual investors focus on their tax-loss selling. But that seems like an opportunity to add to positions because those names more than make up for it in January.

Stocks to target

To identify the best tax-loss-selling candidates, Bank of America screens for names down more than 10% by early October. That nets 338 S&P 500 names this year. Next, the bank singles out names its analysts rate a “buy.” This narrows the list to 159 names.

I believe in diversification, but this is still an unwieldy list. So, here’s what I did for us. Since I follow insider activity closely at my stock letter, I narrow this list by selecting the three names from the 159 buy-rated stocks that have strong insider buying. For five more tax-loss-selling candidates with strong insider buying, check out my stock newsletter. There’s a link in the bio below this story.

Starbucks

Year-to-date (YTD) decline: 27%

Dividend yield: 2.5%

Insider buying: Two directors bought $6 million worth at $92.55 in September

People love to mock Starbucks SBUX, -0.59% because it is ubiquitous. But deep down, consumers love the chain.

We know this because of Starbucks’ powerful brand and size, its capacity to keep expanding in the U.S. and abroad, and its ability to continue hiking the price of its already expensive coffee.

Like ’em or not, these are also the core strengths that will pay off for Starbucks investors for years to come — and pull the stock out of its current doldrums aggravated by tax-loss selling. Here is a little more detail on its three core strengths.

* Brand and size: Starbucks is the largest specialty coffee chain in the world, generating $29 billion in sales in 2021. This heft gives it a big cost advantage over competitors. The strong brand puts a moat around the business.

* Growth: In the first three quarters of this year, sales grew by 10%, or $2.9 billion, thanks to an 8% increase in comparable-store sales and a 5% increase in the store count. The brand strength helps it successfully open new stores. Starbucks opened a net 318 stores in the third quarter, bringing the count to 34,948 globally.

* Pricing power: The company has increased prices 6.8% annually in the U.S. over the past five years, far in excess of inflation.

These three assets will help Starbucks power through the three challenges weighing on its stock this year, rewarding anyone who buys now with a multiyear time horizon. These three issues are all arguably temporary, anyway.

* Inflation: It’s bogging down profit margins. Third-quarter operating margins fell to 15.9% from 19.9% because of commodity inflation. But inflation is cooling and commodity prices are falling. These favorable trends will continue, easing margin pressure.

* Rising wages: Like a lot of companies, Starbucks faces wage pressure induced by labor shortages — the other main hit to quarterly margins. But as labor force participation gets back to normal, wage pressures will ease.

* Sluggish China: A huge part of Starbucks’ growth story is in China, where the government continues to lock down its population to try to stem the spread of the coronavirus. This has hammered Starbucks. Comparable-store sales in China decreased 44% in the third quarter.

But at some point Covid weakens or Chinese officials stop trying to fight the inevitable spread of the virus. Then the long-term China growth story will get back on track.

Morningstar analyst Sean Dunlop expects double-digit sales growth in China through 2031. He projects mid-single-digit unit growth globally through 2031, mainly in the U.S. and China. “Starbucks remains a compelling long-term growth-at-scale story, with average annual top and bottom-line growth of 10% and 12% through 2031, respectively,” he says. That’s impressive growth for a company as big and as “unloved” as this one.

Warner Bros. Discovery

Year-to-date (YTD) decline: 51%

Dividend yield: none

Insider buying: The CFO and two other insiders bought $1.2 million worth in August in the $14 range

For nearly a century, movie fans have adored Warner Bros. WBD, +0.39% classics from “Caddyshack” and “Batman” to “Cool Hand Luke,” and timeless blockbusters like “42nd Street” and “Casablanca” from the 1930s and 1940s.

But behind the scenes, the company that makes these great flicks only gets slightly more respect than the guy who keeps yammering after the lights go down. Decent profitability has remained so elusive, Warner Bros. has lately been passed around like a bucket of cold popcorn.

The movie powerhouse was picked up by AT&T T, -1.35% from Time Warner in 2018. That didn’t work out too well. So earlier this year Discovery acquired what’s now called WarnerMedia from AT&T, setting up the latest plot twist in the struggle for better profits.

The challenges inherent in turning the film company around help explain why Warner Bros. Discovery stock has tanked so much this year. Investors are pretty skeptical. But the sharp declines set up a good buying opportunity for investors –– both for a rebound over the next few months as tax-loss selling eases, but also longer term.

That’s because the latest deal puts the WarnerMedia turnaround into the capable hands of successful media magnate David Zaslov. The Warner Bros. Discovery CEO has a solid track record in building profitable media empires. He turned Discovery into a global powerhouse. That accomplishment included the integration of Scripps Network Interactive. Discovery also made several successful international acquisitions.

But in a troubling plot wrinkle for investors, the WarnerMedia integration and merger is much larger. So, investors have their doubts. They’re probably underestimating Zaslov. At least that’s what the insider buying tells us. It helps that Zaslov has so much good material to work with. WarnerMedia holds HBO (“Game of Thrones”), WB Pictures (“Harry Potter,” “Matrix”), DC Comics (“Batman,” “Superman,” “Wonder Woman”), Adult Swim and the Cartoon Network (“Rick and Morty”), CNN, TNT and TBS.

Meanwhile, as Zaslov tackles the WarnerMedia integration and turnaround, he counts on his Discovery properties to keep churning out cash, providing ballast. Besides its streaming service, it has five flagship networks called Discovery, TLC, HGTV, Food Network and Animal Planet.

* Discovery offers these pay TV networks in an era of cord cutting. Its HBO Max and Discover+ streaming services also go up against daunting giants like Netflix NFLX, -1.30% and Prime from Amazon.com AMZN, -0.94%, in the highly competitive direct-to-consumer space. At least Zaslov has a deep library of original content and several content-origination machines to support his efforts. Ultimately, he will probably combine or at least bundle HBO Max and Discover+.

* The company also has enormous debt taken on to fund the acquisition. But most of its $56 billion in debt is not due for years, leaving room for the turnaround and WarnerMedia integration to play out.

Digital Realty Trust

Year-to-date (YTD) decline: 43%

Dividend yield: 4.9%

Insider buying: The CEO bought $566,000 worth in September at $113.22

This is an “arms dealer” play on big tech trends: Cloud computing, the Internet of Things, 5G, autonomous vehicles and the digitization of the economy in general. That’s because the company provides data centers that house servers and connectivity technology. It is “agnostic” in that it is not aligned with any particular company. It’s also global, with exposure primarily to the U.S. and Europe, but also Asia and Africa.

Digital Realty DLR, -1.12% is the largest data-center-space company in the world, which gives it a cost advantage over competitors. It has better negotiating power when buying generators, air conditioners and electricity. Because it is so costly for customers to move, it benefits from high switching costs. This creates more dependable sales. One challenge is that rising interest rates increase the cost of debt used by this real estate investment trust to acquire or build out new capacity. But if this reins in any temptations to speculate, that’ll be a good thing for investors.

Michael Brush is a columnist for MarketWatch. At the time of publication, Brush owned WBD. Brush has suggested SBUX, WBD and DLR in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.