Saturday, November 15, 2014

DDD: My fix for the end of the year.

Occasionally I get this urge to take on some risk in my portfolio. Not for any other reason but to keep investing interesting and exciting. For the last six  months I have found the market just too hard to invest in. My core holdings, the nine stocks that I hold are either fairly valued or expensive by my analysis and I have no interest in adding to them at these levels. I obviously don't want to sell them either because I don't want to keep trading core positions. Though I feel like the markets are extended, they seem to be in a funky state were there is a great deal of faith that the markets will continue to go up for the rest of the year and even if it doesn't the downside risk is limited due to portfolio rebalancing by bug funds. With that in mind, playing the short side of the market is just too hard. Does not bode well for my remaining short positions on the SPY for the end of year, but I leave it there as my insurance.

So what can I do for now. This is were options are so vital in my investments. It helps me place bets on long odds with minimal capital. So here I am talking about DDD.

At the beginning of the year this stock was flying high and was atrociously expensive. But just like everything else, the good times had to end. Today DDD suffers from all kinds of negative sentiment. Lets list a few:

1. System upgrades and production delays hurting revenue growth
2. Profit margin pressure from product mix
3. Big players stepping into the market in the form of HPQ and GE
4. General negative sentiment on the market segment

So what does DDD have going for it at these levels

1. A 35% short position that will be squeezed at some point
2. Cleaning up of the production delays
3. A balance sheet that looks pretty clean for a company growing at these rates
4. Cash and debt levels that keep the company finances fairly healthy through rough times
5. A positive cash flow that does not eat into the financial health of the company.
6. Another year or more of time before the big competitors get into the market
7. A market cap of $3.6 Billion that is palatable as an acquisition target

So what is the trade? It is a 2016 call option for a strike of 35$ for the price of $6. The assumption here is that by the start of 2016 DDD would have worked through its production issues and would be firing on all cylinders and at that point the shorts would be squeezed out. They would also be a lot closer to the $1 Billion mark in revenue which at 41$ (my "in the money" for the option) would mean that DDD would be trading at 4 times revenue which would not be a stretched valuation anymore. This should also be time enough for them to show new market segments and some additional partnerships that fend off the competition. If they keep up their growth I think the stock should be in the mid 60s by 2016 with a market cap closer to $7 billion.

Clearly this is a speculative trade. But that is what makes it exciting and at a cost of $600 it is worth the price to keep me engaged in the market.

Only time will tell.

Expanding horizons

I had started this blog in an effort to chronicle my investment ideas. I did find a nice outlet for this in Seeking Alpha. So, for the last few months I have been blogging there. I am posting the links here so that I can find them years from now in case I forget. What Seeking Alpha gives me is a feedback loop from complete strangers on the ideas that I propose. This has great value since the feedback is unbiased (towards my writing) and not watered down by association with these people. It is a great outlet for my need to put out ideas and get some thoughts on it. I do hope to continue posting here when I want to put up a quick trade.

But for now, here are my postings from Seeking Alpha.

Thoughts on a three way deal between EMC, HPQ and VMW:

Bailing on Sears (just too hard):

Lessons learnt the hard way:

A security story for VMW:

My big bet for 2016:

By best investment thus far. I still hold that value for MSFT is at 44$. The market might take it higher, but I will add if it falls below 40$.

Tuesday, July 15, 2014

An Earnings Hedge with INTC

As mentioned in an earlier post, I have been looking to get out of INTC. Not because I think INTC is done with its run, but I have some apprehensions of a run up in INTC based on history. Following are my reasons to get out of it:

1. INTC has run up 22% this year over a lot of bullish talk in the semiconductor space
2. INTC has mode most of its run up in the last 3-4 months.
3. Semiconductors are a precursor to capital spending and generally runs up before the overall technology run
4. Semis are cyclical and by the time the capital spending theme takes hold, they have built up too much inventory
5. I just have too much technology in my portfolio and INTC is not the one I want to continue to hold.

Having said all this I say goodbye to a 4% yield with a heavy heart. So lets see what I like about it.

1. The tremendous tail winds it is experiencing right now
2. The 4% yield
3. A capital spending cycle that has just started
4. The confidence with which management took up its earnings projections for the year

The last point potentially bodes well for the current earnings call going to happen today. But I really cant afford to hold INTC through another disappointing cycle. So here is the hedge.

Sell 60% of my INTC holdings. This is all of my buy from 10 years ago at a cost of 30$. So the tax implications of the sale would be very minor as opposed to selling the remaining 40% which has a higher profit and hence greater tax implications. But I do want my upside if there is a surprise today on the call.

So Friday expiring call options with a strike of 31 at a cost of 90 cents. Anything above 40 cent upsdie will pay for the trade.

Fingers crossed. Hopefully with an upside... I will continue to hold the 40% for some more time bfore dumping it later this year.

Saturday, July 5, 2014

Going Organic - WFM

The sign of a well run organization, from a shareholder perspective is a consistently good RoE. If a company shows consistently better RoE compared to competitors, it is a sign of a management responsive to the shareholders. A number of things play into an improved RoE including high profitability, growing retained earnings, a shrinking float, low debt and many other factors. So it is not everyday that you look towards retail, or even worse, towards a grocery store for these characteristics.

Hello, WFM!

Whole Food Markets (WFM) has been synonymous with organic food and the brand is held in high regard when it comes to a great "natural" shopping experience. It is a "Trader Joe's" sort of experience but at a larger scale. I have to admit that I have not shopped too many times at WFM, but when I have, I am almost amazed at the "farmers market" style of shopping in there. Everything seems more like a real market, the closet you can get to a real market, in the world of big box retailing I suppose. The quality of the products is also very impressive, except for their relatively higher prices. But I guess you pay up for AAPL don't you?

Lets set aside the experience and look at the numbers:

1. Forward P/E of 22 - At expected 10% revenue growth it is high but not off the charts
2. RoE of 15%+ - For a grocery store this is pretty impressive. Costco is one comparison I can draw
3. Debt - 60 Million. - This is off the charts for a grocery chain. You goto to love this as a shareholder
4. Growing retained earnings - Even in the last quarter were net income shrunk
5. Relatively small - Still only 300 odd stores in terms of overall size is very small.
6. 1 time sales - You are not paying too much at current levels - though not that cheaper compared to other low margin grocers.
7. Enterprise value - less than 1. Not that far out for a grocery store but on the cheaper side though
8. A dividend - Small one, but something nevertheless for a growing company.

Now with all this said, the market is not at these levels for no reason. WFM has been showing signs of struggling with competition, both from companies like Safeway that has made a push into organic in a big way and  Sprouts that is making a direct go at WFM. Sprouts, especially, is going the rout of slashing prices to catch up with WFM. This is very costly for WFM that is trying to be a premium service in a cut-throat market. Much like APPL in the desktop/laptop market. Couple of quarters with bumpy Net income showing has also made the market nervous about the prospects of WFM.

With all that in mind, the thing I like most about WFM are the same things I like about AAPL.

1. A strong brand recognition for a market segment
2. A resistance towards "slash and burn" approach to pricing and marketing
3. The incredibly low levels of debt for a grocery chain
4. A very low number of stores and the opportunity to expand - given the low debt load
5. A management that seems shareholder friendly
6. A market that is disillusioned with the name
7. Apparently, a founder that is a non-conformist.
8. Close to 8% short interest - Compared to a industry average of about 2-3%

Having said all that, I would jump in today if the stock was less than 35. At 39 it is not too far out. I could buy some now and wait for the pull back in the off chance I do not see the sub 35 pricing. Maybe I will do just that. I just need some convincing to get there. I am working on it. Maybe the way to do it is to sell some Intel at 32$ (I am yet to sell it seeing the momentum into earning) and go into the grocery business.

Thursday, June 26, 2014

Is now the time for some protection?

What I see right now in the market is a volume deprived trading environment with a whole lot of large caps including the ones I am holding treading lower while the indices are all pushing higher. This to me is a sign of a market top, atleast for the short term. When markets are pushing ever higher with low volumes it is a sign that buyers have dried up but the sellers are not coming in either. So all we are really waiting for is a catalyst to set off the sellers. I believe the trigger are the following:

1. With GDP shrinking 2.5% some companies are bound to miss earnings. So bad headline numbers for some big names would possibly trigger some selling
2. Inflation is showing signs in multiple reports and so the chatter of FED raising rates is going to get louder. This is again headline news that might trigger a sell off.
3. The market is at all time highs with no significant correction for over 2 years now.
4. Last few days the market is opening significantly lower than its closing.

So I am thinking about getting some protection to the downside. The trade on my mind is the S&P index put options for the oct-dec timeframe. The options have been getting costlier last few days - a sign of market sentiment turning.

But as my previous post suggests, playing the short side of a trade is hard as hell. I am keeping my eyes open and my fingers quite, but one of these days I think I am going to get me some protection from this rather precarious looking market.

Saturday, June 7, 2014

The week gone by

The markets surged higher last week and hit all time highs on the S&P and Dow. But the rally seems exhausted, dragging its feet as it is unwilling to go down. Admittedly the news on the economy is getting better and that is probably why the market is not willing to give up any of the gains. But I am not sure if the next quarter will have any surprises. I expect most of my holdings to report inline with maybe a couple of surprises to the upside and I think most of it is already priced into my stocks. But I do have a few notable things that happened last week that I would like to highlight.

1. Good sense prevailed and BRCM finally gave up its cellular ambitions. Like when they gave up on Disk controllers, this is a watershed moment for BRCM as profitability and RoI will appreciably improve and the stock showed it this week. Come 40$ I think I will start trimming those holdings. I think it will have legs till 45-50$.

2. Financials seem to be finally getting some legs. I am all invested in with XLF. Nothing much to do there except go on the ride for the next few years. Maybe I will add a little more if XLF breaks 23$

3. GE finally broke out of its range and got some legs last week. I think their backlog and shift to industrials is really gaining momentum. Again nothing much more to do there - as I am mostly fully invested.

4. INTC also broke out of range. I am looking for a 30$ handle to get out of INTC. Too much technology in my portfolio.

5. MT went below 15$ and I added. Lets see how long I will have to wait for this to turn appreciably.

6. Finally AAPL showed some legs. But hard to tell whats coming with the stock split. Hopefully, in the near term some momentum from retail investors and maybe news of addition to an index or two with the lower price. (DOW?)

Friday, May 23, 2014

Waiting fatigue

In a previous post "Dangerous Times" I had mentioned the itch to do something prematurely. This is that time. I am getting the itch to do something and the market is not showing its cards. For the most part most of my portfolio is fully valued. By that I mean that most of the scripts that I hold are at DCF cost price for me and adding to them at this time with no change in fundamentals will simply increase by cost basis beyond the DCF value, taking me into an uncomfortable territory in terms of risk to capital.

I have seen this movie before. The market keeps treading water while everyone is itching to go either way. This is indeed the most dangerous time. The last time this happened was in 2006 when the market was at its highs but not really doing much more. I kept getting the itch to do something and kept adding to my portfolio. Finally when the market turned my cost basis was too high. So I shall try and suppress my itch for now.

Having said that MT is pulling back and that is one place I would like to add.  Maybe below 15 I will. Anyway, till then the market and I will play chicken to see who will blink first.

Wednesday, May 7, 2014

Apple by the numbers

This company always cracks me up. Not because of its absurdity but because of its sheer profitability. What is even more astounding about this company is it is a devices company that swims in the waters where other big fishes grapple with low margins and rapidly changing consumer tastes. But that discussion is for another day. Today let me see if I can make a case for Apple based simply on the backward looking fundamentals.

Apple (AAPL) by the numbers:

1. Cash : 155+ billion dollars (80% of it outside the US)
2. Debt : 16 + 12 billion dollars (raised for the sole purpose of buybacks and dividends)
3. Return on equity = ~30%
4. Accelerated buyback at lower levels - AAPL bought back 17 billion (close to 4%) around 520$
5. 44+ million iphones and 24+ million ipads in last quarter for an "aging" product line hitting almost two years.
6. A new level of shareholder friendliness with 35% increased buyback (buyback stand at close to 18% of float) and increased dividend that has a ridiculously low payout ratio of 10% of total cash flow.
7. A stock split that has not impact on the finance but should have a significant impact of sentiment given possible addition of the most valuable company to the Dow.

So whats not to like:
1. Possible attack on margins
2. An aging product line, that if not refreshed, might end up making the company irrelevant
3. A stock profile that might track other famous large caps through a period of stagnation as the company tries to protect its core market rather than disrupt and innovate.
4. The brain drain that has occurred in the last two years as the stock languished.

So what is it worth:
1. Lowest EPS estimate for next year: 41$
2. Cash on hand : 42$

Assuming a base P/E of 8 times (which would mean a 5 year horizon with compounded returns) and a 3-5% organic EPS growth through new product introductions along with and additional 3-5% positive impact of buybacks on the EPS, "Simplified DCF" projects an acceptable P/E of 10 times earnings.

That would bring us to 41*10 = 410$
Add back the cash = 410+42 = 452$

That indeed is my real intrinsic value for AAPL. If I were to think that the team in AAPL might have something up their sleeve for second half of this year (as indicated by Tim Cook) and on the off chance that it is a success (beyond the larger iphone) lets me go wild and add another point to the P/E (Equivalent to an addition 5% of EPS growth).

Then we have:
41*11 + 42 = 451+42 = 493$

So there you have it. 493$ is what I would call a safe place to initiate position or dollar cost average a lower cost position at this stage in AAPLs life.

Obviously the market is way ahead of the game and AAPL is at 592$.

Monday, April 14, 2014

Buying Protection

This strategy has always cost me money rather than saving money or better yet, making money. Ideally, I would like to hedge my portfolio with a protection instrument that would offset my losses in the portfolio to make sure that my overall quarterly performance does not take a beating every time the market decides to have a panic attack.

The easiest ways I have come up with are the following:

1. Buy puts on individual shares (refer my last trade for lessons learnt :-))
2. Buy puts on S&P (Kicking myself for not doing that inspite of a thesis of market direction)
3. Buy double/triple short ETFs for markets indicies
4. Buy VIX or options on VIX (By first experiment with protection)

I have to say that I have tried all these strategies to varying degree, but to little success. The have little faith in (3) and (4) because as I track these instruments I find that there reaction to the negative side is far more violent compared to their trends to the upside. When you buy an instrument you would expect to have a symmetrical instrument, but the short ETFs are not for the faint of heart. When the market tanks, it does trend up, but when the market goes up, these instruments really take it to their chin. Seems like people have more confidence in their negative trend and are too nervous holding it than owning it. The same can be said about the VIX. During the Great Recession, the VIX was a great indicator and I did play it a few times, but now I see that the VIX has become a poor indicator, again carrying a bias to the negative side for the trade that it provides.

For (1) I think I have already harped enough. The key is to make sure you have a thesis on the stock and play the thesis rather than getting too aggressive or too safe on the bet. A hard balance to strike. But the key is to have the conviction and go for it without overplaying it. So I do think there is some merit here if your conviction is high.

Which brings us to (2). This is the one I am yet to play, to my own surprise. After all isn't this the most obvious way to protect yourself? I would think so, with the assumption that your portfolio is diversified enough to be represented by S&P. Having said that I have not yet devised an effective way to play the short side of the index. Should I buy a 2 year put on S&P when the market is really roaring, and keep it as protection was the rainy days? When do I sell it and get out? When do I I roll into a net option as the current one ages?

Here is a theory (and I am yet to try it)

Buy put options three years out, when the market is up 10-20% and hold it for the first year. If you have a 10-15% correction, sell out of the options (and this is where you get exposed to further downside) and buy into the options again when the market turns up by 10%. The other option is to hold it till expiry if you are in the money and get exposed only when you have to sell it. In either case, the key here is to buy it when things are rosy (like Jan 2014) and sell out in times when the market is looking hopeless. Even if you don't get it perfectly right in the timing, as long as you get the general direction right over a period of 2 -3 years you would have protected your long portfolio to some extent.

Having said all this, I find the short trade a very hard one to play due to the time restrictions on the trade. Best would be to research the long side and accumulate it as the market swoons to reap it when the fundamentals have finally played out.

But then, where is the fun in that, right?

Saturday, April 5, 2014

So close yet so far

I am sorry for harping on the same trade again, but there are two reasons I publish this post.

1. To claw back some self respect for the losing trade that I made on FEYE a month back
2. To explain why the adage "Market can stay irrational longer than you can stay liquid" is a lesson in humility and something that should never be forgotten.

Yesterday, FEYE hit 50$. This is a good 10$ below my target price for the short trade I had proposed a couple of months back. And true to the calculation, FEYE is heading back to a valuation that is closer to 10 times revenue like its peers. If you compare that with the chart for PANW, PANW has been able to hold on to the levels that it was at when I wrote the first post about this since it was already hovering around 10 times revenue. Needless to say that the slump in the market is slowly becoming a reality with all the momentum stocks taking it to their chin in the last couple of weeks. So in summary I take solace in the fact that the thesis on my trade was intact.

Now for the second lesson and the more important lesson. I played an aggressive hand on this trade. Though my thesis said that the slump would be here by summer, my trade tried to get ahead of that thesis and got into a time horizon that was way more aggressive than my own thesis. Instead of buying the march puts, if I had stuck to the thesis of May time horizon, I would now be in the money on that trade by 20$ that translates to 2000$ per option.

On that note. I shall close the chapter on this trade. Lesson learnt!

Saturday, February 22, 2014

Perils of the short trade

I was so confident that FEYE was overvalued that the short trade that I described in my earlier post seemed like a no-brainer. Funny thing that I still stand by my valuation of FEYE from the earlier post, but the fact remains that it was a losing trade. So what happened? Why did my years first trade take a bite out of my 2014 returns, which I will have to work hard to overcome for the rest of the year if I have a chance in hell of meeting or beating the market.

Lets review:

1. The quarter report for FEYE was inline with the expectations that were known to me as I got into the trade. For a high flyer like FEYE, that would mean a disappointment and should have taken down the stock. Not surprisingly it did, and it took a 12% hit post earnings.
2. The day before the earnings the stock was hovering around 72$, when it was hit by a upgrade from Wells that took the stock up 8%. This was a killer because the downside risk of the stock was padded due to this run up before the earning and though the stock took a 11% hit after the earnings, it was not enough to get me back to 65 for a break even on my trade.
3. The momentum on the stock was so powerful that the stock got right back above 70$ and stayed there for the rest of the time.
4. The volumes were not that strong post earnings, a sign that there was no conviction on the upside but there was no body going after it.
5. The ultimate sign of momentum was that FEYE even announced a 10% dilution and the stock simply shrugged it off.

So in summary everything about the valuation seemed spot on, except I did not have time on my side. The market overall went the wrong way as I was expecting it to trend lower further pressuring high filers like FEYE, but instead the market showed tremendous resilience. And even though I still think that the market is going to swoon sometime from here to May, I did not have that luxury with my trade that ended yesterday.

So lesson learnt. Never bet against a momentum stock on the short side, if you do not have time on your side. Always assume that the market has staying power longer than you and so unless your time horizon is infinite, you need to bail out of a trade if the immediate result of your trigger is not strongly biased towards your calculations. For example, FEYE hit 67$ the day after the report. This had my option trading at almost 7$ and I should have got out since my calculations did not pan out and the stock was no where near 60$ as predicted. Given the momentum the stock had to the upside, I should have sold immediately and walked away. Instead I held on and never got a chance again to get out as the stock roared back and then treaded water.

Now I need to be careful. After taking this hit I have lost some of my flexibility to risk my portfolio for 2014 as I do not want to underperform the market under any circumstance. So risk if off for now... and a lesson is well learnt.

Sunday, January 19, 2014

First trade of 2014

The market seems to be unsure what it wants to do and most of my holdings currently do not provide me with the opportunity for a compelling buy. Not that I have lost confidence in my holdings, but just that given all the metrics that I watch, none of them are yet at a point where I can pull the trigger to add more to my positions. It doesn't help that the market has run up so much without a breather.

My gut feeling tells me that the market wants to correct but the bulls are reluctant to let it go. However my prediction is that things will stall after the earnings season into April. Given the first set of earnings, things are not on fire on the long side and the earnings were only lukewarm at best. So there should be no reason for another leg of rally as far as I can tell. So I plan to wait for a stall/pull back before adding more to some of the positions I would like to add to.

In the mean time what do I do? Well there is this stock I have been watching rally close to 50% in less than 5 days that has my fingers itching. The company is FireEye and it is the latest hot startup to go IPO last year. The past 6-12 months has been a great year for web security companies and I have to say that PANW and FEYE has made full use of this timing to go IPO.

While I do not question there long term viability given the great expanse of the networks that need to be protected, I am getting a little wary of the valuations on both these companies. More so on FEYE than on PANW.

Some facts on FEYE

1. At current stock price the market stands at 8.8 billion
2. The company has a revenue of 150 million (giving it a Price to sales of 60+ while even PANW is at 10+)
3. Even with the latest acquisition and the best of analyst surveys the next years revenue is at 450 million (Which gives it a 21.6 times revenue valuation)
4. They are expected to have negative earning in the next year too.
5. Operating margins are currently at a eye popping -90%

Given it is a new IPO the numbers are hard to parse, so I am just going with the revenue guidance and to trade at 20 times the most bullish revenue guidance seems a little too much even for FEYE when PANW is at 10 seems excessive.

So for lack of activity in the market I decided to do a trade on FEYE. Following is the trade

1 70$ put option expiring on Feb22 bought at 5$

The trade comes with two assumptions

1. The Feb 11 earnings report will meet analysts expectations of revenue guidance
2. The valuation will then come closer to PANW which has been in the market longer

So where is my trade at? At 5$ on the option my real trade starts at 65$. So at 65$ we are talking about a 7.7 Billion market cap at 19.8 time revenue. So assuming the bloom comes off the rose on Feb 11 and yet the market likes the premium of FEYE over PANW, I expect the market to take FEYE down to 16-18 times revenue which is 60$ a share which should give me a 100% return on my investment.

Then why only one contract? Well because the market momentum for this stock seems to be too much and I have paid a little more than I would have liked for the contract. If the market rallies further I will add to this contract holding as it gets cheaper, but the reason to pull the trigger now was because I think the rally on this stock was too quick to last very long and the moment the violent upside stops, the puts will start getting costlier.

Mind you here that the more established players like Checkpoint (that makes money for the past so many quarters) trades at just less than 10 times revenue.

So that is the first trade for 2014.