Advisor Overheard

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.