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Nitin Gulati
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As a value driven investor, my investment approach is safe and cheap. I focus on investing in companies with extremely strong financial positions offering future growth at a discount. I take that same top-down approach and apply a synthesis of market implied growth rates in securities to isolate... More
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Dynamic World of Options &Volatility Trading
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  • Can Google Rebound- Most Critical Earnings Event

    Google (GOOG, GOOGL) is scheduled to report 1Q2014 earnings after the close of trading on Wednesday, April 16th. For the March Quarter, analysts are expecting earnings per share of $6.41 (Range: $6.00 -$6.83). For FY 2014, analysts are expecting revenue of $66.47 billion dollars implying 11.10 percent year over year growth.

    For the last 14 quarters, Google's stock has on an average moved 6 percent, next day after the earnings release. Table below presents how the options market has historically priced at-the-money straddle for Google before earnings (in percent terms, standard deviation terms, and the implied volatility levels). Also included in the table is volatility crush that happens in the options after the earnings are released.

    (click to enlarge)

    Heading into the earnings this week, the risk reflected by the options market (30 and 60 day implied volatility levels) is marginally lower than the all time highs levels seen last week. For the earnings event , options market is expecting a 5.85 percent move, which is close to the average move in the stock for the last 14 quarters. From an implied volatility perspective- ATM straddle seems overpriced, but appears to be priced fairly on an absolute move basis.

    Despite missing the consensus sales estimates in seven of the last nine quarterly reports, market has rewarded Google on the hopes of its multiple revenue streams in future. Besides, the strong growth reported by the Internet software and services industry lifted the growth expectations for Google as well. Decomposing Google Price/ Earning ratio reveals the growth premium built in its stock price. Google stock has lost 13 percent after making an all time highs earlier this year. Even at current market price levels future growth accounts for approximately 50 percent of Google's price.

    Implied volatility for long-term dated contracts in Google started to rise before the stock became a victim of momentum reversal in the technology sector. Implied through this divergence in volatility regime from the broader market is the magnification of risk in Google' stock beyond an earnings event.

    (click to enlarge)

    As the market unwinds the future growth premium from high growth stocks, any metric miss from Google can exacerbate the volatility in this stock for the next few months.

    Disclosure: I am short GOOG.

    Additional disclosure: Short Google via Sep Options

    Tags: GOOG, GOOGL
    Apr 16 8:50 AM | Link | Comment!
  • Why I Agree With Goldman's Bearish Gold Call

    Last week, Goldman Sachs downgraded its outlook on gold (NYSEARCA:GLD)for 2014 and their view essentially rests on "US economy reaching escape velocity". Beneath the surface lies, an important driver that certainly needs to happen if, the economy picks up in the later part of this year. Extra return demanded by investors (equity risk premium) will start declining as the economy picks up momentum. Earlier this year, I presented my long-term bearish argument on the gold, highlighting the relationships gold has preserved with equity risk premium as well as the structural shifts currently underway globally. Shortly after, I recognized and shared with the readers the shift in volatility markets that signaled an upside move in gold for the short term.

    Before discussing and putting the current macro environment into the context for gold prices, let us re-summarize the key drivers, which effect gold prices in the marketplace.

    1. Equity Risk Premium
    2. Corporate Profits & Corporate Equities Multiple

    Risk premium investors demand vary as a function of uncertainty in the economy as well as the risk aversion of the investors. To put it more intuitively, risk premium should decline as volatility in economic variables such as expected inflation, economic growth and interest rates diminishes. During the financial crisis of 2008, equity risk premium rose to levels last seen during late 70's.

    This year's gain in gold prices came on the backdrop of rising risk premium-, which reflects investors rush to seek the safety of safe haven assets. As the short-term regime of rising premium shifted, so did the gold price. With the economic recovery in progress, risk premium has declined from its highs but still is at extremely elevated levels. One can argue about this deviation from long-term mean as a possible long lasting shift. I welcome this argument but my only strife would be that applying this argument alone distorts the reality.

    This brings us to my second driver - Corporate Profits and Equities Multiple, which affects gold prices in the marketplaces. Corporate profits and the S&P500 (NYSEARCA:SPY) earnings have tracked each other closely since 1947. Historically, corporate profits have peaked out before the S&P500 earnings, which is because of the time lag with reporting of corporate profits. However, acceleration in rise in earnings for S&P500 relative to corporate profits underlines the surge in optimism among the market participants. In addition, when the stock returns outpace earnings growth, earnings multiple expands. Phases of earnings multiple expansion and contraction coincide with the bull and bear markets in the gold prices. Chart below displays the relationship between the gold prices and corporate equity multiple (drawn from ratio of Federal Reserve's Account of Corporate Equities to corporate profits after-tax).

    (click to enlarge)

    Multiple contractions witnessed from 2000 to 2012, and the rise in equity risk premium explains the rise in gold prices from $300/ ounce to $1900/ ounce during the same time.

    Long-term median for corporate equities multiple since 1950's is 11, putting current multiple of 12.25 in a slightly overvalued category. Current market valuation is no way near to the valuation levels we noticed during tech and the housing boom. Valuation bears have been pointing towards the high, unsustainable levels of profit margins and are calling out for the "normalization of profit margins in future". In applying the argument over a long lasting shift in the economy, we should accept the current valuation levels as representing current economic reality and respect the change, which US economy has undergone. This will infer current market as fairly valued with a strong likelihood of multiple expansion. Earnings multiple expansion in equity markets will exert strong downside thrust on the gold prices.

    Such a scenario in combination with low inflationary pressures will create tailwinds for equity markets, thus money will continue to rotate out of safe heaven assets such as gold and treasury bonds.

    Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in GLD over the next 72 hours.

    Tags: GLD, SPY
    Mar 31 11:08 AM | Link | Comment!
  • A valuation perspective on Whole Foods
     Being the largest natural and organic foods grocery store the country WFMI has grown amazingly over the last few years. Company operates over 280 stores in 38 US states, District of Columbia, Canada and UK. Company is revamping its pricing strategy and concentrating more on value offerings, while maintaining healthy margins.This strategy is best suited in present economic climate where consumers are trying to spend more smartly, gain more value on every dollar they spend. Even though WFMI targets affluent people as their potential customers, company's focus on putting value in perspective is helping it gain more customers then expected and is dynamically expanding its customer base. Improved same store level performance, controlled inventory management are key factors driving earnings growth for this company. There is ample room for new store openings in future, as company management has clearly  expressed interest in accelerating the pace of its store openings in coming years driven by the fact that more people are going to adapt to healthier lifestyles. . Buoyed by healthy financial position and robust financial outlook, board re-established the quarterly dividend $0.10/share after a gap of more than two years. Over the last year stock has been up 65% whereas S&P up 10%. Question remains for people who have missed the ride so far ! Is it too late to get on this train to enjoy the potential price potential and small dividend yield .
    From a intrinsic valuation perspective, factoring in 16.35% projected earnings growth for next 5 years, healthy operating margins, WFMI will be fairly valued at $66/share.  Stock is presently trading at 0.93 times revenue and has the potential of expanding Price/Sales ratio to 1.26.  




    Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in WFMI over the next 72 hours.
    Tags: WFM
    Jan 10 12:33 AM | Link | Comment!
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