Arctic Cat: Buy The Market's Hesitation

| About: Arctic Cat (ACAT)

Investors in Arctic Cat (NASDAQ:ACAT) have been in for a wild ride this year. At one point, shares were up 35%, however volatility has essentially left the year unchanged. Through this article, I will place the price movements of ACAT into fundamental perspective and provide a bullish analysis for this security.

A Steady History of Returns

In order to objectively analyze ACAT, I have relied heavily on return on assets and return on equity. Return on assets is the net income of the firm divided by average total assets and this key metric tells investors how efficiently the organization uses its assets to generate income. Return on equity is the net income of the firm divided by directly-invested shareholder equity and this ratio tells analysts how well the company uses investments to generate profits. In the chart below, 5 years of returns can be seen for ACAT.

It can clearly be seen that returns have experienced two distinct time periods over the past 5 years. The first time period which we will examine is the months between 2008 and the second quarter of 2009. This period of time was marked with fundamental malaise, as measured by return on assets and return on equity. Firm performance was only profitable for two quarters and the stock price suffered by declining around 40%. This period was very difficult for shareholders both in the security and in the overall market, but ACAT was able to deliver hope to shareholders in the second half of 2009. Beginning in the third quarter of 2009, ACAT began delivering growing fundamental performance and within two quarters, the firm was once again profitable. This profitability led to a prolonged period of growth which has lasted until this day. Interestingly enough, the share price of ACAT only increased for the first two years of this period of growth. Between the third quarter of 2009 and the first quarter of 2012, shares increased around 340%. A very interesting development has occurred throughout the year of 2012. This year, fundamental performance, as measured by return on assets and return on equity has greatly increased. Over this same time period, share price has essentially experienced lots of volatility and traveled nowhere. The table below summarizes these fundamental periods.

This decoupling of firm performance and share performance provides an investment opportunity. As history has shown, a clear relationship exists between firm performance and stock performance. As a firm improves itself, shares tend to increase as well. This is due to the fact that an improving firm is likely to attract investment capital from investors seeking returns. This clear relationship has dictated share price returns for the past 5 years, until now. I believe that we are witnessing a clear investment opportunity within ACAT. The firm is experiencing strong and consistent growth and improvement, but shares have been hesitant to follow this performance. It is my belief that in the future, the market will wake up to the fact that ACAT has a consistent history of returns and investors will once again purchase this organization. For investors seeking a strong return, I advocate purchasing shares of ACAT.

Technically Speaking

Fundamentally, I believe that ACAT is a strong organization. Even though I believe that prudent investors should consider this security, I do not advocate immediately entering the stock. I believe that individuals should wait until price provides a clear investment opportunity prior to buying the company. As seen in the chart below, I believe that ACAT is locked within a broad trading range. Price has recently bounced off of the bottom support of the trading channel and I believe that we should experience price increase in the immediate future. In my opinion, investors would be wise to wait until price overcomes $38.00 per share, prior to initiating a position in ACAT. This has been a hotly-contested region over the past year and I believe that a struggle could occur when price reaches this threshold again. For investors who purchase the security at $38.00, I believe that a stop-loss should be placed at $32.00. This will protect capital in the even that this trade idea doesn't work out as anticipated. As soon as the trade hits the upper-end of the current trading range at $46.00, I believe that investors should strongly consider selling one-half of all shares in ACAT. History has shown that price will more than likely remain in this range, and technically speaking, investors would be wise to take profits at this resistance barrier. If price is able to overcome this barrier, I believe that a final stop-loss should be set at $46.00 to protect capital should the trade reverse back into the trading range. Investors who hold beyond this point should strongly consider exiting ACAT if fundamental performance experiences a decrease, as measured by a downtick in return on assets and return on equity.

The table below shows a breakdown of the trade recommendation as well as the expected payoff. The trade is favorable in that in the base-case, we can expect to earn $1.33 for every $1.00 we are willing to risk. It is important to understand that this is a fairly-low payoff, but this assumes that price essentially goes nowhere. As history has shown, returns should be driving price to 5-year highs right now and I believe that in the future, this is entirely possible. In the past, returns have driven share price direction nearly 100% of the time, and if you believe that this will more than likely happen in the future, then you are better off buying Arctic Cat at $38.00 per share.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.