Archive for February, 2011

A Valentine’s Day portfolio

Sunday, February 13th, 2011

While dining at a fancy restaurant years ago, I happened to overhear snippets of a conversation between two very chicly dressed woman at a neighboring table. One woman was complaining that she was tired of her lover showering her with jewels and expensive perfume when all she really wanted was a portfolio of stocks and bonds!

In some cases at least, it seems that diamonds are not a girl’s best friend. If you’re a guy and your significant other seems to be more practically minded rather than romantically inclined, then please read on because I have some terrific Valentine’s Day stocks for your security-minded gal.

The Valentine’s Day Portfolio
The most popular Valentine’s Day gifts are lingerie, perfume, jewelry, flowers, and chocolate. Listed below is my Valentine’s Day portfolio of US exchange traded stocks that will be sure to delight your loved one.

Lingerie: The 800 pound gorilla in this space is Victoria’s Secret, owned by Limited Brands (LTD). The company, incidentally, owns Bath & Body Works, a fragrance and spa specialty retailer. (This one company could kill two portfolio categories with one stone, but the perfumers merit their own mention.)

LTD clawed its way back from pre-recession lows hitting a new $35 high in December. The stock promptly tumbled and began consolidating. It was boosted out of its doldrums on February 3rd by blowing out January sales figures and raising Q4 guidance. Several days later, the stock pushed above $32 resistance and looks poised to test its next resistance at $34. The company will report earnings on February 23rd after the closing bell. It also pays a 2.4% dividend yield.

Perfume: Despite the fact that almost every perfume is now made with synthetic ingredients (of which many cause severe allergies and some are downright carcinogenic), women still plunk down dollars on scents. Of the publicly traded companies in this field, International Flavors & Fragrances (IFF) is by far the largest player–but is it the best?

Let’s take a look.

In its latest earnings report, the company said that increasing costs for raw materials plus increased R&D and marketing expenditures all took a bite out of the bottom line despite strong sales growth from emerging markets. In spite of this negative news, the company was upgraded the very next day but investor enthusiasm was dampened by an analyst at Morningstar who came out and said that the company faces numerous headwinds in the form of cost inflation and a fragile consumer spending environment that are likely to pose challenges for the company in the months ahead.

Enter the other two perfume players: Inter Parfums and Parlux. Inter Parfums (IPAR) reported better than expected third quarter earnings and analysts expect 14% growth in 2011, according to Zack’s. The stock is consolidating after flirting with its $20 all-time high in mid-December. It may just remain in its current holding pattern until it reports fourth-quarter earnings on March 9th.

In terms of market capitalization, the smallest member of this group is Parlux (PARL). But don’t let it’s small size fool you—technically, it’s been performing extremely well.  It recently broke out of a long period of consolidation and is enjoying a strong upward trend.

Fundamentally, the company’s prospects are looking up. Its strengthening balance sheet boasts a strong cash position, no long-term debt, and a net book value of $4.94 per share (the stock is currently trading around $3.50). The company’s CEO cites a revised selling strategy and a dramatic reduction in operating expenses as the reasons for the marked improvement in operating income. He is predicting 2012 sales to be in the $145-$150 million range which is 16-25% above the 2011 fiscal year forecast.

Note that only IFF and IPAR pay dividends (1.9% for IFF; 1.4% for IPAR).

Jewelry: The two most compelling stocks in this area are Signet and Tiffany. Signet (SIG), whose brands include Kay and Jared, is the discount go-to jeweler of choice. Although it’s closed some of its bricks-and-mortar establishments, same store sales have risen. The stock is trading near its multi-year high of $45 which also happens to be an area of major resistance. If it can break through that, the next hurdle will be its all-time high at $50.

My favorite of the two is Tiffany’s (TIF). What woman doesn’t get weak in the knees when presented with a gift packaged in one of their signature blue boxes? Better than the box, though, is the company’s balance sheet which shows expanding growth in emerging market hubs especially the Asia-Pacific rim. It’s last quarterly report showed a 10% increase in same-store sales pointing to increasing strength in high-end consumer buying.

The stock hit its all-time high of $65 in mid-December and is looking to retest it soon. Unlike Signet, Tiffany does pay a dividend (1.5%) and it’s options field is much more robust.

The one negative mark against both of these companies is insider trading which has been very heavy in recent months.

Flowers: The only publicly traded company in this space is the internet floral and gift-basket retailer 1-800-Flowers (FLWS). On January 27th the company beat second quarter estimates citing improved margins. This announcement caused the stock to jump by 12%. Several days later, Zack’s added it to its #1 strong-buy list. Unfortunately, that did little for the stock which has been trading sideways since.

Overall, the stock price has been slowly rising. It has yet to face serious resistance in the $3.50 – $5.00 range which it hasn’t been able to top in over two years. The company also faces serious competition from Teleflora, FTD, and Amazon. Of all the stocks mentioned in this article, this one is the least compelling both technically and fundamentally.

Chocolate: Although Kraft and Cargill both have chocolate concerns, Hershey’s (HSY) is still the leader of the pack. The company’s Q4 report matched estimates but investors were cheered by the company’s cost-cutting program and successful commodity hedging which prompted an analyst at J.P. Morgan to up his price target to $54 from $50.

But the picture is not quite so rosy considering that the source of the product—cocoa—is under severe scrutiny by human rights activists. Most of the world’s cocoa is produced in West Africa using sweat-shop tactics while ignoring child-labor laws, and activists are encouraging the public to boycott chocolate this Valentine’s Day and send their own “Valentine’s” emails to Hershey’s urging that the cocoa they buy be certified free of abusive labor practices. How you feel about this is between you and your conscience and could be a real moral dilemma for die-hard chocoholics.

*insert HSY chart

Technically, the stock has been channeling between $46 and $52 since last April. Before taking a long position, I’d wait for the stock to clear its channel high. This company also pays a dividend (2.7%).

So instead of the usual Valentine fare, consider the stock equivalent portfolio. It’s easier to purchase, much less fattening, and most of the stocks pay dividends. And what girl doesn’t like a gift that keeps on giving?

Take advantage of positive stock events to generate income

Saturday, February 5th, 2011

Income seekers are always looking for new ways to generate cash into their accounts. One tried and true method that is particularly suited for bull markets is that of the covered call. For those of you unfamiliar with this strategy, it consists of selling a call option against underlying stock held long. [For those of you familiar with the covered call strategy, you can skip to the bottom.]

Covered call strategy overview
There are two ways to estimate your expected covered call return. The first is the assigned yield which occurs when the stock trades above the strike price of the option and is called away (assigned). In this instance, your return on investment (ROI) is the following: [(strike price – stock purchase price) + option sale price]/stock purchase price.

The other return is called the unassigned yield. If the price of your stock trades below the strike price of your sold option at the option expiration date, you will retain possession of your stock and your ROI will then be given by the following: option sale price/stock purchase price.

You can see that the unassigned yield will always be lower than the assigned yield, but the trade-off is that in the former case you get to keep your stock and in the latter case you lose it. So which approach is better?

That depends on your point of view. Most folks looking for income want to achieve the assigned yield, and the sooner the stock is called away, the better. Why? Because they can immediately put that profit to work by writing another covered call, hopefully while the market is still hot.

On the other side of the coin, those looking for stock appreciation will probably not want their stock called away. If this is so, then a covered call strategy is working against them. However, if your stock has enjoyed a long run-up and you’re concerned a correction is overdue, then writing a covered call offers a bit of downside protection. How much? The calculation is exactly the same as for the unassigned yield shown above. Your break-even point, i.e., the point below which you start losing money, is the stock purchase price less the option sale price.

Covered call opportunities
Income investors seeking the maximum assigned return should be looking for those stocks with positive momentum. Some of the best picks are the market darlings.

The problem with many market darlings is that can be expensive. Look at the prices of Apple and Google. To set up a one-contract covered call strategy with either of them would cost you $35k and $62k respectively–you’d have to be Daddy Warbucks to set up these trades!

A better way is to seek out the rising stars that are still affordable.  How can you spot a rising star?  Look for those companies that have recently been recipients of good news such as analyst upgrades (the more analysts piling on, the better), a new product line, better than expected earnings, rising same-store sales, a successful drug trial, or an upgrade in forecasted earnings and revenues.

All of these are proven stock movers, and the more of these a company can get, the faster its stock will appreciate. Typically, analysts will upgrade a stock if the company blows out earnings and guides earnings per share and revenues higher. But analysts tend to jump on the train after it’s left the station, so in some cases an upgrade isn’t very meaningful.

Covered calls on raised earnings
I like covered calls on upgraded earnings revisions, especially if the stock has been performing well before the announcement. That means that investors have confidence in the health of the company. Here are four stocks that were rallying before their companies raised guidance. [All of these stocks can be found in the Subscriber Services.  There are currently 140 stocks in the earnings upgrade database.]

Cirrus Logic (CRUS): Chip maker Cirrus Logic has been a media darling for a while (it’s one of the Big Booyah’s favorites). The stock broke out of a five month base on Jan. 27 when it announced that it beat earnings estimates and upped Q4 revenues from $85.61M to $88-$94M.

Skilled Healthcare (SKH): This nursing home operator raised its FY11 outlook on January 6th causing the stock to pop by 14%. The company guided its EPS higher by a whopping 34-45% and raised revenues fron $857M to $880-$900M. It will report earnings on February 15th.

Skyworks Solutions (SWKS): Chip and electronic subsystems maker Skyworks Solutions has been a stellar performer, steadily rising from a low of $4 two years ago to its current price of $35—that’s a 775% price appreciation! If you’ve been holding this stock for a while, you may want to take a few of your own chips off the table as it’s now trading at a trailing P/E of 38 which is much higher than its industry P/E of 18. The good thing about the covered call strategy is that it offers you some downside protection, just in case the stock decides to take a breather.

Teradyne (TER): Automatic test equipment maker, Teradyne, is the third member of this covered call group from the semiconductor industry. It’s system-on-a-chip (SoC) test rig is used in mobile phone technology which is fueling its explosive sales growth. On January 26th, the company upped Q1 guidance by an entire quantum level, raising EPS from $0.19 to $0.33-$0.39 and revenues from $295.44M to $350-$375M. The stock gapped up 11% on the news and has been rising since.

Here’s a table showing the assigned and unassigned returns for some February and March near-the-money covered calls.

Note: Although the open interest on the SKH March call is low, there has been decent volume on it so it’s worth putting in a limit order.