1 Stock To Buy, 2 Stocks To Sell, And What's Next For The Market

Includes: DIA, DIS, IBM, SPY, TSLA
by: David Ristau

The market made quite a rebound from last week to start the shortened week. Stocks rallied on the back of better Consumer Confidence numbers and a rise in housing prices as shown by a better Case-Shiller 20-City Index. Consumer Confidence rose to a multi-year high coming in over 76. Expectations were for just over 72. The Case-Shiller Index showed a 10% rise in housing prices in March as well.

Both signals were very positive for the economy. Shares, however, did drop from the open as concerns over Ben Bernanke's QE cuts still are on the minds of traders and investors. As we noted in our weekly outlook, good news in the economy is not good for the continuation of QE, which has provided a lot of upside for the market. The Dow Jones increased 106 points while the S&P 500 increased 10 points.

Stocks to Trade

Today we are looking at a bullish position in Disney (NYSE:DIS) and a bearish position in IBM (NYSE:IBM), as well as taking a deeper look at the value in Tesla Motors (NASDAQ:TSLA).

We like the looks of Disney right now. Shares recently made a slight consolidation, but bounced back on Monday on the news that Yahoo (NASDAQ:YHOO) bid for Hulu over the long weekend for around $600 million to $800 million. Disney is a part owner of Hulu along with News Corporation (NASDAQ:NWSA) and Comcast (NASDAQ:CMCSA). We believe that DIS has a lot of positives moving for it right now: Summer weather brings in crowds to Disney theme parks, recent movies and TV have been wildly successful, and DIS has value plus earnings power.

We like the seasonal play on DIS. The company derives about 25% of income from its theme parks, and we believe that the summer season can be very beneficial to the company. In its latest quarter, the company highlighted that travelers were coming back to parks and spending money strongly (an 18% increase in operating income in Q1 in theme parks), and we believe that trend should continue throughout the summer as employment levels have risen and wealth has increased with the market at all-time highs. Here are comments from the company about its travel division:

Spending on hotel rooms increased 6% as Disney continued to reduce promotional rates put into place in recent years to counter the recession, according to James A. Rasulo, Disney's chief financial officer. He told analysts during a conference call that room bookings for the next quarter were running above levels of a year ago by a 'mid-single-digit' percentage.

Another portion of the DIS business that is very solid is TV and movies. In the last quarter, the TV division saw a 12% increase in operating income, and Q2 could be huge for ESPN. In the April-June time period, ESPN has been seeing strong viewership of the NBA Finals, the NFL Draft, and the start of baseball season. The NFL draft had exceptional viewership, while the NBA Finals has been mixed but still draws a lot of viewers. Sports have become an integral part of American TV culture, and we believe that DIS will continue to benefit from its growth. Movies have also been solid thus far in the quarter. "Iron Man 3" was a box-office hit, becoming the fifth largest grossing film of all-time at this point. "Oz" made over $400 million as well for another box office success in the quarter.

Things are rolling at DIS right now, and the future looks bright for the rest of the year. Sports success is not going anywhere, consumer spending is on the rise, and the company has more potential box-office successes with "The Lone Ranger" and "Monsters University" from Pixar. Right now, shares are trading at a 16.6 future P/E and 2.7 price/sales ratio. Neither ratio screams value, but the stock is also not overvalued at this time as well. Analysts are expecting a 7% increase in revenue year over year along with a 15% increase in earnings for the year. The stock is solid, and we like adding it long with a bull put spread.

  • Trade: DIS, Long and DIS, Jul20, 62.50/60 Bull Put Spread
  • Entry: Now on stock, 0.30 on spread
  • Targets: $70, $75 and 0.00 on spread (max gain of 14%)

Click to enlarge images.

We definitely like the upside potential in IBM for 2013, but we are cautious about the next one to two months as we head into the next earnings report and the market starts to look more toppy. The problem for IBM in its latest quarter is that it was was not able to complete as many deals as it wanted to complete or that it thought would be done. Here are comments from IBM's Senior VP Mark Loughridge about the last quarter:

In the first quarter, we reported $23.4 billion in revenue, expanded gross pretax and net operating margins and delivered operating earnings per share of $3, which is up 8% year to year. But this quarter certainly didn't close the way it started. We had solid profit performance in January, but as the quarter ended hundreds of millions of dollars of very profitable software and System z mainframe deals fell short of the goal line. This impacted the first quarter close, but the rollover of these deals positions us for a strong start in our software and mainframe business in the second quarter. Taking full consideration of our first quarter performance and the number of actions to improve this performance, we continue to expect operating EPS of at least $16.70 for the year.

As we noted in previous articles about IBM, one of the main reasons we liked it was a cyclical strong period for the company in its System z mainframe that was newly developed and would replace old systems. The problem, though, is that demand has not been as strong as we expected, as noted in the last report. Even if deals are closed in Q2, what does that mean about deals that were originally thought to be done in Q2 -- do they move to Q3? That question mark is a big one and that leaves the market uncertain about Big Blue.

The stock has rebounded about 15% since the report came out, and that rebound has brought the stock back to pre-earnings levels. The stock has shown resistance at $210, and we believe the market needs more proof that System z sales are showing strength in Q2 before the stock can make more headway.

The company reiterated earnings outlook last week that was as expected with FY 2013 EPS at 16.70. Analysts are expecting 16.67. The company is expecting double-digit growth in EPS in Q4. The cycle for demand may end up being more in the second half of 2013 rather than the first half as we had originally expected. Therefore, we still like the stock for the year, but we believe that the stock has topped out for now. A great way to play IBM is to be long the stock, but also put on a hedge with a Jul20 215/220 bear call spread. That spread is offering nearly 30% in max gains.

  • Position: IBM, Jul20, 215/220 Bear Call Spread
  • Entry: 1.20
  • Targets: 0.00 (max gain 30%)

Finally, we want to price Tesla Motors today to see just what investors can expect for the company moving forward. Here is how to calculate price targets using discounted cash flow analysis (all figures in millions):

Step 1

Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.






Income from Operations






Income Taxes






Net Op. Profit After Taxes






Plus: Depreciation






Less: Capex






Less: Increase in W/C






Available Cash Flow






Step 2

Calculate the present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / (1 + WACC)^# of FY years away from current. For example, 2016 would be 1 / (1 + WACC)^4 (2016-2012).

WACC for TSLA: 6.00%






PV Factor @ WACC:






PV of Available Cash Flow:






*For 2017, we are going to calculate a residual calculation, as we believe that the market tends to value companies with around a five-year projection of where business will be. This is the common projection for discounted cash flow analyses.

Step 3

For the fifth year, we calculate a residual calculation. This number is calculated by taking the fifth year available cash flow and dividing by the cap rate, which is calculated by taking WACC and subtracting out residual growth rate. Residual growth rate is typically between 2% and 6%; 4% is average growth for the industry. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. This is why higher growth companies tend to have higher P/E ratios. We will give you the cap rate.

Cap Rate for TSLA: 1.0%

Residual Cash Flow


Divided By: Cap Rate (r-g)


Equal: Residual Value


Multiplied by: PV Factor


PV of Residual Value


Step 4

Calculate Equity Value: Add PV of residual value, available cash flow PVs, current cash, and subtract debt:

Sum of PV of Available CF During Projection Period (2008-11)


Plus: Present Value of Residual Available Cash Flow Value


Fair Market Value of Enterprise


Less: Interest Bearing Debt


Plus: Excess Cash


We have added in current cash/cash equivalents as of the latest fiscal quarter along with debt levels.

Step 5

Divide equity value by shares outstanding:

Implied Equity Value


# of Outstanding Shares


Implied Price Per Share


As we can see with TSLA, shares were undervalued pre-earnings. The above, we believe, is a best-case scenario, though. The low cap rate is about the lowest it could be, and the risk for TSLA is high. Therefore, we believe that shares are now getting to a level where one may want to sell. At the same time, TSLA has lots of potential and, while it may be done for this year, if we start to project out again for next year, the upside will be even higher.

Market Outlook

Tomorrow, the market will look to continue to add to its Tuesday gains. Wednesday is a light day for the market with no major economic data or earnings to be announced. With a lot of volatility in the market right now, it is hard to predict the market. The things to watch for tomorrow will be overseas, as Japan and Europe have the largest influence on the dollar and American markets right now. Bank of Japan Governor Kuroda will make a speech tomorrow and talk about Abenomics. His words will be parsed over like Bernanke's to see how things are going -- especially after last week's debacle. German Unemployment Change will also be announced tomorrow. A good report there can go a long way to improving the look of green shoots in the European economy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The Oxen Group is a team of analysts. This article was written by David Ristau, one of our writers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article