Advisor Overheard

July 9, 2012

Further Rallying in $WCG to be Technically, Not Fundamentally, Driven (for now)

$WCG is running this morning, and I was tweeting about the confluence of technical and fundamental flags that were in place for a reversal this past week. These included (with the stock trading around $50):

1. Breaking the downtrend that started in April 2012.
2. Trading at a 5 year trough price to earnings multiple
3. Trading at a 5 year average price to book multiple
4. A healthy current ratio
5. Generally low analyst earnings expectations with trailing earnings at 8x and forward earnings at 10x (versus the 5 year average of about 15x).

Now in the low 60s, the stock is up over 20%, and despite feeling good about a nice and quick profit, I have to review the position. I like to think of half of my positions as fundamental and the other half as technical. The best opportunities come when both fundamental and technical attractiveness occur at the same time (like finding a girl with smarts and beauty, or when Rahzel sings and beatboxes at the same time). This takes patience. In this case, the fundamental half is telling me to take profits while the technical side is telling me to ride the trend. Let me break this down:

Fundamental Half: While a higher earnings multiple is definitely possible (especially with earnings coming up on August 3rd), $WCG already trades at a premium to average price to book and sales (see links above). In fact, if we just look at our average PE of 15 – that puts the stock at $101, and an average PB of 1.9 – that puts the stock at $51, then it’s no surprise that the average Wall Street estimate is around $76 (an average of these two targets). I blend price to sales, profit margins and a quant tool in as well, putting my target at $63. Fundamentally we have mean reverted (for now). Sell.

Technical Half: $WCG has broken its downtrend on multiple time frames at a previous support/resistance level, it has a positive sloping 200 day average, it is above the 20 and flattening 50 day, it has a positive MACD zero line cross, there is good breakout volume today and a big gap up says we should revisit the prior highs in the low 70s. The 20 Day average can now be a managed stop loss if not tighter to preserve profits. Technicals say Hold.

This is just one (well 2) way(s) to think about a stock and manage a position. The market has been tough and my individual trades have not been as rewarding as my core asset allocation (see my other posts and tweets if interested). It is sure nice to catch a winner once in a while though.

Leave a comment

June 20, 2012

Why I am Not Buying $YHOO Here

Much has been said about $YHOO lately (Phil Pearlman has been one of the best commentators/traders of the name to observe in my view, making excellent use of options to build his position. I highly encourage reading his posts as well as following @mojoris1977 and @ragincajun) I have avoided the name despite their fundamental views and the increasingly attractive technical set up because of a few factors which I’ll discuss below. Please note that this is not a short idea, but the very impressive and convincing opinions of others doesn’t quite jive with what works for me. It is crucial to know when to just “sit one out.”

1. Since late last year the stock has traded over 3.5x revenue, a number well above the 2.4x 2008 trough, and near the 3.7x 5 year average. While I agree there is revenue to be unlocked, I am not sure it deserves an average let alone above average multiple at this stage. The stock is already near an average value by this measure.

2. With regard to earnings, which would separate the money kept from revenue, we can use the earnings yield since EPS went negative in the dark days of 2009. By this mark, at 5.3% we are not far below the 6.2% peak achieved in September of last year. This is saying the stock looks pretty cheap and could “normalize” propelling the price into the 20s. Earnings yield tells us a much more optimistic story than the price to revenue multiple.

3. If this disparity exists between sales and actual earnings, where are the profit margins? At 23.45%. They peaked closer to 30% in March of 2008, but the stock is not trading like it’s at a top. It is trading in a tighter and tighter range. Profit margins are a far cry above the 5 year average of 13.7%, which may be making earnings based valuations a bit flattered. This is what has me most leery.

If revenue can grow and margins stay healthy, YHOO should break out of this long, narrowing range and realize a more normal earnings multiple via a higher price. If this occurs it will make a great long trade for those discussed at the beginning of this post. If revenue and/or margins stall or fall however, they may find they overpaid for those earnings. For now, I am happy to watch and learn.

Leave a comment

June 18, 2012

Tactical Trade Thesis: $CSCO

Before you read this, note that I am sharing this not as a recommendation, but to display the process the team I am a part of employs when picking tactical trades for our clients’ accounts. Don’t expect any further info about this trade.

Over the past 2 weeks we’ve added $CSCO to our tactical portfolios. The thesis sounded something like this, “We are adding Cisco because we feel that: 1. the fundamental backdrop of trading at prior trough valuations combined with 2. the technical backdrop of reversing momentum to fill a large downward gap will pull investors into the stock driving the price up potentially by 30%+. If we are wrong, we can easily set a stop to keep us out of holding onto what may turn out to be a value trap.”

I will post an explanation going into the details of how we pick and size tactical positions “by the numbers” in the near future. In the mean time, organized by category, here are some of the areas we look at, and where relevant, levels and targets are stated.

1. Average ttm PE has been 17.76, trough has previously been around 12. Currently $CSCO trades around 12.5. Target here is 24.
2. Average price to book has been just over 3, trough has been 1.8, which is where it currently trades. Target here is 30.
3. Average price to sales has been just over 3, trough has been 2, which is where it currently trades. Target here is 27.
4. Profit margins are average and not expected to change greatly in the near term. No target, but we want to make sure they aren’t running at peak margins here either.
5. A current ratio around 3.5 shows the company is on stable footing financially for the near term. No target, but this is worth checking with a falling stock to make sure they aren’t having funding problems.
6. Comparing debt to equity, the company has virtually no debt to be concerned with. No target, but this is also worth checking for a falling stock.
7. Weekly on balance volume indicates the weak momentum it has experienced in May’s gap down, but it is not a wash out. No target, but this looks normally corrective.
8. The 200 day moving average is around 18.5, with 2 standard deviations below sitting at 14.44. The average itself is the target here.
9. At only about 8% below the 200 day moving average, this is above the overextended 20% below experienced in major bottoms, and in the range of a normal correction. No target currently except the average.
10. Weekly MACD is bearish but flattening. No target, looking for confirmed reversal going forward. Daily is positive suggesting upside for filling the gap.

Using the targets listed above and weighting them accordingly with our models, we came up with a downside target of about 15, which was close enough to catch our attention when the stock broke 16 last week. This indicated our “start to buy” point. Our current target for a mean reversion based tactical trade is 23, and we will manage a stop somewhere around the 20 day moving average. The model and objectives are dynamic, and we will observe how they change over the lifecycle of this trade. Note that most of the information we use can be obtained for free from YCharts and Stock Charts. These are two invaluable resources.

As I said before, I fully intend to dive a bit deeper into construction, weightings and position size in a future post. Feel free to leave comments or ask questions.

Leave a comment

June 14, 2012

Debunking Variable Annuity “Improvements”

AO = Advisor Overheard. That’s me. VA = Variable Annuity Wholesaler. For those of you outside of the industry, the insurance companies that make products like variable annuities have their own sales staff who push the product to the real salespeople, the Financial Advisor / Planner community. Annuities are an important part of the planning arsenal, but in the end, insurance is insurance. You pay for some form of protection and that’s that. In exchange for your money, the insurance company offers you some future benefit, which in this case is a stream of lifetime income. Creative marketing, complexity, and the fees everyone collects along the way take over from there. You can learn about the product itself here or here if you need some background.

VA: Hi, AO, do you have a moment? I wanted to tell you about the improvements and adjustments we recently made to our variable annuity contract.

AO: Hi VA – thanks for keeping me posted. Let me guess, you’re cutting the withdrawal rates? These low long term yields have got to be brutal on your underwriting…

VA: Well, actually we are raising our guaranteed withdrawal amounts. That’s the improvement I am calling to tell you about.

AO: OK, I am onto your game, so then what did you do to your guaranteed growth rate?

VA: You always are keeping me on my toes AO. We have reduced that. But here’s the thing. We’ve gone from 10% down to 7%, simple interest for as long as 10 years garaunteed growth, BUT, like I said, we’ve actually raised the gauranteed mininum withdrawal amount from 4.75% up to 5%. So pending how you look at it, that’s still a pretty good deal.

AO: Improvement implies I get more though – those numbers tell me I get less. By I, I mean my client of course.

VA: Well you do get more on the withdrawal side, you are right that you get less though on our guaranteed growth benefit.

AO: But THAT is exactly the problem. You can’t seperate the two. For sake of the insurance contract, they are truly inseperable. Listen, tell me what you’d prefer. Option A is I could give you a 3% growth rate per year, simple interest, with a 6.75% withdrawal rate, Option B is a 7% growth rate, so way higher growth, with a 5% withdrawal rate, which is not that much less. Option C, this is the crazy stuff, is I’ll give you a 14% garaunteed growth rate, but a 3.5% withdrawal rate. Comparing A to C, A has over 5 times the growth rate for just over half the withdrawal rate. You’d take C, right?

VA: Okay, yes – but I get the feeling I’m being setup…

AO: Damn straight you are! This is “Figures Lie and Liars Figure 101.”

VA: This is why you don’t give me more business?

AO: Don’t knock me off of my soapbox yet. So in A, if you’ve got $100,000 to start with, that’s going to generate $3,000 a year for let’s use the industry standard of 10 years before you can start taking withdrawals. Simple interest gets us to $130,000. 6.75% of $130,000 is $8775 of income per year. Option B – same $100,000 to start, grows to $170,000 and taking it out at 5% gives you… drum roll please… $8,500 per year. Finally, good old amazing option C grows to $240,000 and pays out a whopping $8,400 per year.

VA: I see your point.

AO: You just can’t seperate these two numbers.

VA: So because I know you have work to do – let me just say, our benefits are lower than where they used to be.

AO: Speak the truth brother. Low interest rates are killing savers, and they aren’t helping you out here.

VA: Anything you need, just call.

AO: Thanks VA.

Please notice that I didn’t touch on the actual costs of a VA contract or any of the other ugly stuff. If you’re not familiar with annuities read the links mentioned above. I’ll tear through the product in a client annuity review post in the near future. There’s also a good article from Linda Stern at Reuter’s that at least says your old annuity might be worth keeping because of those promised benefits from days of higher withdrawal rates. She’s on the right path.

Leave a comment

May 27, 2012

Test, test, 1, 2…

Sometimes you just have to get in the ring.

I am a Financial Advisor with a big bad company who doesn’t quite understand social media. For no better explanation than “it’s complicated,” I have been forced down the path of anonymous blogger. You can piece together the pieces to my puzzle as posts get posted.

Leave a comment

Follow “Advisor Overheard”