Tag Archives: contests

How A Magic Goldfish Might Short The Stock Market

Summary US equities look wobbly. Buying downside protection is in vogue. Skew is high. Let’s put it to use. Put on your contrarian boots Market participants are wired to cheer for bull markets. Anyone even marginally attached to the finance industry knows what I mean. Every trading floor has a guy with his hair on fire. He is screaming about an imminent collapse in the stock market. He spends his days reading David Stockman’s blog and cruising Zerohedge. Sometimes he mumbles things about an electromagnetic pulse. The marketing department spends at least three hours of every day thinking up ways to get him fired. Nobody likes that guy. Not even me. (Despite my affinity for Mr. Stockman. And let’s be honest, who doesn’t like themselves some good Zerohedge?) Anyway, markets are structurally wired to be long only. Bears have been earning themselves a bad rap since 2009. Here is a fun trick that you can use to avoid ridicule while showing your bearish side. Just call it “Portfolio Protection” One reasonable way to play the trick is to buy put options. Sometimes people ask me to teach them things about options. I start by warning them about the dangers of being a goldfish. It is my adaptation of the 10th Man’s explanation for why efficient market theory is nonsense . Goldfish have crappy memories. They probably don’t spend much time thinking about the future either. When the goldfish gets to the future, it doesn’t think about how it got there. The goldfish is just living in the moment. Think about that if you are using charts like this to analyze an options trade. This is what I call a “goldfish chart.” It is a slice of what the goldfish’s wallet might look like when the option expires. On expiration date, you could ask the goldfish how it got there. It’ll shrug and say something like, “I don’t care.” Don’t be a goldfish I mean, you are probably not a goldfish. You spend a fair amount of your time thinking about your portfolio. You probably care about what your profit and loss will be tomorrow. You certainly care what it will look like when you retire. You pretty much continuously care about your portfolio performance. Goldfish charts narrow your focus onto some arbitrary date called “expiration.” That’s dumb. Much to do about skew While going through the morning routine here, I came across this little gem entitled “Who’s the Bear Driving Up the Price of U.S. Stock Options? Banks” All it really says is that the implied volatility curve is highly skewed. But that sounds like rocket science. So, the author did a really nice job breaking it down. If you want to buy a put to protect against losses in the Standard & Poor’s 500 Index, often you’ll pay twice as much as you would for a bullish call betting on gains. Get it? There are a lot of market participants with their hair on fire. They are bidding up high prices on out of the money put options. Portfolio protection is getting expensive. Let’s create a synthetic security! Sounds like fun, right? There is some magic math we could do to create something that looks a lot like buying a put option on the S&P 500 (NYSEARCA: SPY ). [Long Put] = [Short Put] + [Long Call] + [Short Stock] Let’s not think about it too much. Just take my word for it. To a goldfish, the combination of things on the right of the equals sign (the “Synthetic Put”) looks a lot like the thing on the left of the equals sign (just a normal put). Remember when that guy at Bloomberg said that buying puts cost twice as much as buying calls? Take another look at that synthetic put. [Short Put] + [Long Call] + [Short Stock] The goldfish wants to buy a put. But puts are expensive. So instead, the goldfish sells an expensive put and buys a cheap call. Short some stock and… Voilà! That my friends is magic math. How a magic goldfish might short the stock market Let’s do some magic goldfish math. We would like to buy an SPY put with a 204 strike and a March expiration. The market is asking $7.90 for that at the moment. Here is the goldfish chart again. We could just buy the overpriced put for $7.90, but that’s dumb. Let’s build a better mousetrap. We sell a 173 strike SPY put for $1.30. Then we buy two 210 call options for $4.58 each. Adding those things up we have paid $7.86 in net. Then we short 200 shares. Here is what the synthetic looks like compared to the at the money put. That is magic charting! At about the same price we are getting much more protection. How can this be? I have a couple of theories. Maybe three theories. One is that the market is structurally wired to trade long only. The typical market participant doesn’t have a margin account with permissions to go out selling put options and shorting stocks. But the banks do. Why don’t the banks jump in and arbitrage this? I have a theory for that too… First, this is not really “arbitrage.” The synthetic is very short skew. That doesn’t matter much to a goldfish, but it matters a lot to a hedge fund, or a bank, or someone like them. It should matter to you too! You’re not a goldfish. Second, if you are a bank, you are probably going to have a hard time explaining to Mr. Dodd or Mr. Frank what you are doing. Try telling a politician you want to add downside protection by selling a put and buying a call. It sounds a little bit like bullish speculation. The politician is not going to be interested in your magic math. The trade Anyone considering buying portfolio protection should be looking at a synthetic put. Skew is high. It could go higher. There are some other risks. Like, the market is not giving me an early Christmas present. Still, it feels like I would be sufficiently compensated for going short skew. Maybe you will feel like that too. But don’t go out creating synthetic securities just because a stupid chart looks attractive. Don’t be a goldfish.

Entergy Corp. Reports Solid Cash Flows From Operations

Summary This utility with a 5.14% dividend yield deserve a closer look. The decline in natural gas prices has led to a droop in wholesale electricity prices, harming Entergy’s profits. We use the company’s trailing 12 month P/E to get a better price comparison with industry peers. Regularly generating cash profits is an essential component of successful businesses. It only makes sense that’s how many investors wish to see their investments perform as well: as cash machines. Shark Tank investor “Mr. Wonderful” Kevin O’Leary agrees, emphatically stating, “cash is king.” And dividend payers like Entergy Corporation (NYSE: ETR ) churn that stuff out. The utility sector has recently crashed, with many companies trading at or near 52-week lows. Choosing the strongest companies from the lot is a fantastic opportunity to lock in great long-term deals on serious cash machines. Entergy Corp. trades at $66.69 per share, near its 52-week low of $61.27. Their dividend yield is a juicy 5.16% at this price level. During the third quarter, Jim Simons’ hedge fund increased their holdings in this company by 1.02 million shares – that means his research team concluded the company is trading at a discount to its intrinsic value. A clear indication that Entergy is worthy of further investigation. Entergy Corporation serves the growing suburban markets of Texas and operates in Arkansas, Mississippi, and Louisiana. They also distribute natural gas which is becoming more commonly looked upon as a commodity of growing importance in man’s fight against climate change, even as natural gas producers themselves are not presently thriving due to vast oversupply. The company is off of its 1-year high by 27.5% as the utility sector has generally gotten whacked by the market since February of this year. Financial Results & Removing A Big Non-Cash, One-time Impairment Charge Focusing on their operations, the company has announced the shut down of two loss-making power plants. The impairment write-offs and writedowns associated with the closure of the Pilgrim and FitzPatrick nuclear power plants took third quarter results to a net loss of $4.04 per share. I’d like to get closer to the Price-to-Earnings figure without this one-time charge baked in. After we removed the one-time charge we can easily compare the per share price ratios of Entergy Corp with its industry peers. First we’ll take a look at what third quarter 2015 results look like with and without the unusually high impairment charges, then we are going to bake-in Other Income, Interest Expense, and Income Taxes to arrive at an earnings figure that is comparable to industry peers. Note: The company’s 2012, 2013, and 2014 annual reports indicate asset impairment charges of ($ in millions) $255,524, $241,537, and $179,752, respectively. We will use the average of these three annual figures, divided by 4, to estimate the typical impairment charges per quarter. This will allow us to take a view of the profitability of the company aside from the plant write-offs associated with management’s work to improve operations. The average of the indicated impairments for 2012, 2013, and 2014 is $225,604. Divided by 4, that’s $56,401 of average quarterly impairments — the figure used in the image below. Time to review operating expenses with and without the recent quarter’s decommissioning related impairments: Taking another step closer to an industry-comparable earnings per share figure we’ll add in Other Incomes of $43,179 and subtract the quarter’s Interest Expense of $171,349. Our income before income taxes comes to $492,617. On Entergy’s very profitable 2014 they paid 38% tax on the aforementioned figure. Taking income taxes into account for the quarter we come to our net-of-decommissioning write-off 3rd quarter net earnings figure: $305,423. Finally, we will now find our remapped, industry peer comparable earnings per share and price-to-earnings figures for the 179,151,832 common stock shares outstanding: Retuned 3rd Quarter 2015 Earnings Per Share of $1.70 I selected Southern Company and FirstEnergy Corp. as they are among those enjoying profitability and similar dividend yields. Other peers in the energy utility sector include NRG Yield, Inc. (NYSE: NYLD ), Calpine Corp. (NYSE: CPN ), The AES Corporation (NYSE: AES ), and American Electric Power Co., Inc. (NYSE: AEP ). Entergy’s retuned Trailing P/E of 12.24 compares favorably to larger and slightly larger peers Southern Company (NYSE: SO ) and FirstEnergy Corp. (NYSE: FE ). Entergy enjoys a higher dividend yield and a competitive price-to-sales ratio with its market capitalization neighbor First Energy. Another favorable indicator is the firm’s Price-to-Sales ratio below the average of its peers. Cash Flow from Operating Activities Cash flows from operating activities, net of nuclear fuel purchases and resale, and net of financing costs, bring us to 3rd Quarter cash earnings of $329,628,000. This figure far exceeds their quarterly common stock dividend of $.85 per share, or approximately $154,038,000 inclusive of preferred dividends. It appears that the company can reliably generate enough cash to pay its dividends. Marketplace Interest in Entergy Corporation When a hedge fund with a small army of highly-qualified analysts and access to 3rd party consultants at costs of hundreds of thousands of dollars takes interest in a company by executing significant buy orders, I get interested too. Now, there’s no way to know the exact reasons for the following recent purchases I will outline below but you can be generally assured that these guy’s goal is to make money in a long position through the receipt of dividends and capital appreciation. As mentioned earlier in this article, Jim Simons’ hedge fund added 1.02 million shares of Entergy Corp during the second half of this year. That’s a 70% increase in the size of their position in the company, bringing Jim Simons’ funds’ total position to 2.47 million shares. Millennium Management increased their position by $54 million during the most recent quarter. They own 1,525,275 shares with a value of $99 million. Buying by Hedge Funds far exceeded selling during the second half of the year reported as of September 30th, which is a bullish indicator of smart money sentiment. Conclusion I like Entergy Corp.’s at its yield of 5% and greater. They serve a diverse geography from Texas, to Louisiana, Arkansas, and New York, among other locales. Their earnings figures are solid aside from the one-time decommissioning charge associated with the closure of money-losing nuclear power plants in Plymouth, MA and the FitzPatrick plant of New York State. The Plymouth plant closure is expected to be complete during the first half of 2019 and FitzPatrick’s closure during early 2017 at the latest. Most of the company’s production of electricity is by nuclear power plant. Their profitability has suffered with the collapse in the price of natural gas because it has brought down the wholesale price of electricity in their markets. In general, Entergy’s free cash flow should easily support its quarterly dividend for a long time coming. Utilities such as these folks are the classic example of long-term cash machines. Due to my belief that the marketplace has generally underappreciate Entergy’s ability to reliably pay its dividend, tempered by a reluctance to catch a falling knife where we don’t know whether or not natural gas prices will continue to drag on electricity prices, I rate Entergy Corporation a hold. If natural gas — hence wholesale electricity prices — start climbing again and all else stays the same, Entergy Corporation becomes a clear and even a screaming buy. Click +Follow next to my username to get the latest research beamed to your inbox in realtime Additional disclosure: This article represents the opinion of the author as of the date of this article. This article is based upon information reasonably available to the author and obtained from public sources that the author believes are reliable. However, the author does not guarantee the accuracy or completeness of this article. It is merely the author’s interpretation of the information contained in the article. The author may close his investment position at any point in time without providing notice. The author encourages all readers to do their own due diligence. This is not a recommendation to buy or sell a security

Valuation Dashboard: Utilities- Update

Summary 3 key factors are reported across industries in Utilities. They give a valuation status of industries relative to their history. They give a reference for picking stocks in each industry. This is part of a monthly series of articles giving a valuation dashboard in sectors and industries. The idea is to follow up on a certain number of fundamental factors for every sector, to compare them to historical averages. This article covers Utilities. The choice of the fundamental ratios used in this study has been justified here and here . You can find in this article numbers that may be useful in a top-down approach. There is no analysis of individual stocks. You can refine your research reading articles by industry experts here . A link to a list of stocks to consider is provided in the conclusion. Methodology Three industry factors calculated by portfolio123 are extracted from the database: Price/Earnings (P/E), Price to sales (P/S), Return on Equity (ROE). They are compared with their own historical averages “Avg”. The difference is measured in percentage for valuation ratios and in absolute for ROE, and named “D-xxx” if xxx is the factor’s name. For example, D-P/E = (AvgP/E – P/E)/AvgP/E. It can be interpreted as a percentage in under-pricing relative to a historical baseline: the higher, the better. It points to over-pricing when negative. ROE is already a percentage. That’s why we take the simple difference: D-ROE = ROE – AvgROE. The industry factors are proprietary data from the platform. The calculation aims at eliminating extreme values and limiting the influence of the largest companies. These factors are not representative of capital-weighted indices. They are useful as reference values for picking stocks in an industry, not for ETF investors. The price-to-cash-flow ratio used in my dashboards for other sectors has been eliminated here, because discontinuities and outliers make it often irrelevant in Utilities. Industry valuation table on 11/4/2015 The next table reports the 3 industry factors. For each factor, the next “Avg” column gives its average between January 1999 and October 2015, taken as an arbitrary reference of fair valuation. The next “D-xxx” column is the difference as explained above. So there are 3 columns for each ratio. P/E Avg D- P/E P/S Avg D- P/S ROE Avg D-ROE Electric Utilities 18.06 15.94 -13.30% 1.74 1.22 -42.62% 9.24 10.43 -1.19 Gas Utilities 21.3 17.24 -23.55% 1.4 0.97 -44.33% 10.5 11.49 -0.99 Multi-Utilities 19.44 16.59 -17.18% 1.64 0.95 -72.63% 9.59 9.48 0.11 Water Utilities 22.66 23.68 4.31% 5.06 3.94 -28.43% 3.01 7.96 -4.95 Ind.Power Prod. & Energy Traders* 44.08 34.9 -26.30% 2.59 4.16 37.74% -3.42 -5.15 1.73 * Averages since 2005 Valuation The following charts give an idea of the current status of industries relative to their historical average. In all cases, the higher the better. Price/Earnings: Price/Sales: Quality (ROE) Relative Momentum The next chart compares the price action of the SPDR Select Sector ETF ( XLU ) with SPY (chart from freestockcharts.com). (click to enlarge) Conclusion XLU has underperformed SPY by about 4% in the last 3 months. On this period, the 5 best performing S&P 500 Utilities stocks are NiSource Inc. (NYSE: NI ), Pepco Holdings Inc. (NYSE: POM ), PPL Corp (NYSE: PPL ), SCANA Corp (NYSE: SCG ), TECO Energy Inc.(NYSE: TE ). NI hit an all-time high in November. Valuation factors have slightly improved since last month for Electric and Gas Utilities, but these industries stay in the weakest positions with all metrics in negative territory. Independent Power Producers and Energy Traders are above their baseline in quality, but valuation factors are mixed. There may be quality stocks at a reasonable price in any industry. To check them out, you can compare individual fundamental factors to the industry factors provided in the table. As an example, a list of stocks in Utilities beating their industry factors is provided on this page . If you want to stay informed of my updates on this topic and other articles, click the “Follow” tab at the top of this article.