Knight Capital Group: Buying on the Dip

NITE shares had hit a multi-year high of $23.11 in October before somewhat weaker than expected September EPS knocked their shares back to today’s $16.40 price.

Zacks now expects Knight to earn $1.43 this year and $1.60 in 2010.

Here are NITE’s per share numbers from continuing operations as reported by Value Line:

Year	Sales	C/F	EPS	B/V	Avg. P/E
2004	5.71	0.51	0.36	7.79	31.3x
2005	5.57	0.51	0.34	7.93	26.5x
2006	9.18	1.73	1.49	9.29	10.5x
2007	9.89	1.59	1.24	9.67	12.4x
2008	11.46	2.28	1.94	11.40	8.4x
2009*	10.65	1.80	1.43	11.55	12.6x

* 2009 data includes Q4 estimates

The company is almost debt-free with over $400 MM in treasury cash far exceeding total debt of about $140 MM. Value Line assigns NITE a ‘B++’ financial strength.

Knight’s P/BV is now just 1.4x versus an industry average of 3.07x and the S&P 500’s 3.42x ratio. NITE has sold above 2x book value on many occasions over the past decade.

Value Line sees a long-term multiple of 14 in calculating their 3 – 5 year target price. Based on next year’s estimate of $1.60, that would bring NITE shares to $22.40 within 12-months. That would translate to a 36.5% gain from the current quote and yet would be less than the actual high set just last month. Morningstar is in basic agreement with a published ‘fair value’ for NITE of $21 /share.

Here’s a nice buy/write combination for the next 14+ months that can generate outstanding results with only moderate risk.

	Cash Outlay	Cash Inflow
Buy 1000 NITE @$16.40 /share	$16,400
Sell 10 Jan. 2011 $20 Calls @$1.75 /share		$1,750
Sell 10 Jan. 2011 $20 Puts @$5.00 /share		$5,000
Net Cash Out-of-Pocket	$9,650

If NITE shares rise to at least $20 (+22%) by Jan. 21, 2011:

• The $20 calls will be exercised.
• You will sell your shares for $20,000.
• The $20 puts will expire worthless.
• You will have no further option obligations.
• You will end up with no shares and $20,000 in cash.

That’s a best-case scenario net profit of $10,350/$9,650 = 107%, achieved in 14.6 months on shares that only need to move up by 22% from the trade’s inception price.

What’s the downside?

If NITE shares fail to rise to at least $20 by Jan. 21, 2011:

• The $20 calls will expire worthless.
• The $20 puts will be exercised.
• You will be forced to buy another 1000 NITE shares.
• You will need to lay out an additional $20,000 in cash.
• You will have no further option obligations.
• You will end up with 2000 NITE shares.

What’s the break-even on the whole trade?

On the original 1000 shares it’s their $16.40 purchase price less the $1.75 /share call premium = $14.65 /share.

On the ‘put’ shares it’s the $20 strike price less the $5.00 /share put premium = $15.00 /share.

Your overall break-even point would be $14.83 /share.

NITE could fall by up to $1.57 /share (-9.6%) without causing a loss on this trade.

Summary:

Knight Capital Group looks to represent good value at today’s quote of $16.40 with an expected 12-month target of $21 - $23. Outright purchase could provide nice gains.

Option savvy investors could see even better returns by buying shares while selling January 2011 calls and puts at the $20 strike price. Any move that leaves NITE above $20 on expiration date would translate that minimum 22% gain in the stock into a cash-on-cash return of over 107% for the 14.6 month trade duration.

Combination writers would have a built-in 9.6% margin of safety as the overall break-even point would be $14.83 /share.

Disclosure: Author is long NITE shares and short NITE options.

Comments

[Gravity404:]

These guys have $15.68 per share in cash and yet the stock trades at $16.20.

That doesn't make sense. But that phenomenon worked out well for me when the same thing happened to KBR.

Nov 13 10:03 AM

[Paul Price:]

$400 MM in cash/ 95 MM shares = $4.21 /share

Nov 13 10:47 AM

[Gravity404:]

Yahoo Finance show $1.4 billion in cash.

I guess we all know the reliability factor with Yahoo Finance. Still, 25% of share price...

Nov 13 11:02 AM

[blueblazer:]

Crammer recommends nite at 22, I buy. It's that simple. Ugg, a lesson learned!

Nov 15 11:32 AM

[Paul Price:]

Barrons reported 2 insider buys of NITE totaling 35,000 shares (Nov. 16 issue).

Nov 16 07:52 AM

[drbob66:]

NITE closed at $14.90 today...down 9% since this article was published (and down 35% in less than two weeks time). Clearly, someone doesn't want to own this stock anymore.

GS downgraded NITE to "neutral" from "buy" this week ...and Schwab downgraded it to "sell" from "hold" (both after it had already fallen 30%, of course). Good thing we have professional analysts around to help us with our investment decisions.

Personally, I bought a little at $16.15 before the downgrades (and after seeing that the insiders had bought at $15.50). I guess if it tanks even further, at least the insiders will lose a lot more than I do. Still, it's no fun to see your "investment" lose 10-11% of its value within three days.

Nov 25 06:39 PM