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Tom Armistead's  Instablog

Tom Armistead
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I'm a well-informed retail investor and post on SA in order to expose my thought process to critical examination and comment from readers. It makes me a better investor. I'm particularly proud of bullish macro articles posted in 2009 and later, in which I presented ideas that encouraged me to... More
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  • Opening A Speculative Account

    Please don't stone me for mentioning Jim Cramer. I don't watch him on TV (anymore): but I did read his book when I started investing, and I like his advice about speculation. The point is, it's a natural human activity, you're going to do it anyway, so just limit it to a certain size (20% per Jim) and then go out and have your fun.

    After returning from my hiking sabbatical and reopening my discretionary account, I re-entered the market cautiously and restricted myself to dividend growth stocks, somewhat overvalued, but unlikely to do lasting harm. Long term they'll do fine. The problem is, it's like watching paint dry: investment's too slow.

    Of course funds invested in the Vanguard S&P 500 Index performed wondrously, up 30%, who's counting? That's embarrassing, why not just leave your money with Bogle's boys and go fishing (or hiking)? permanently.

    Recently I set up a Chinese firewall and dedicated somewhat less than 10% of my investable assets to a speculative account. If the money was left in the bank, the rates on CD's are insulting. If you buy treasuries, the return is trivial, and you're bearing interest rate risk. Meanwhile, I can have some fun and make some money. Wall Street is the only casino on earth where you can leave your money on the table for ten years and still have something left.

    After what we went through in 2008 and 2009, it's hard to remember or believe that the stock market has a profound upward bias. The most likely 90 day return, based on history from 1950 to 2010, is 2.43%. Short-sellers and doomsayers will be correct from time to time, and amply rewarded, but the fact remains: the bias is up.

    What I've Done So Far

    Tech companies frequently have strong balance sheets, and many of them trade at conservative valuations. Implied volatility at times is high. There are stocks that have good downside support from excess cash, strong cash flow, etc., but sport low PE multiples and attractive premiums for selling options. I've been doing option trades that bet these situations will not go much lower, and receiving net time premium for doing so.

    Seeking Alpha is not looking for articles on options. With that in mind I plan to do brief write-ups of my trades in my instablog.

    Recent positions include Jabil (NYSE:JBL), Intel (NASDAQ:INTC) and Harmonic (NASDAQ:HLIT), written up in the instablog, as well as Vishay (NYSE:VSH) and Xyratex (NASDAQ:XRTX), which popped shortly after I went long.

    The Jabil trade was a catch the falling dagger ploy, by means of a vertical call spread, with both legs in the money. A similar trade was done on Cirrus (NASDAQ:CRUS), and noted in a comment to another contributor's article. For Intel, the speculative trade is a bullish reversal, based on the idea that the market doesn't appreciate the upside potential there.

    Portfolio Objective

    The immediate motivation for most of the trades is to sell calls and collect time premium. When a vertical call spread is used in an effort to catch a falling dagger, some of the temporarily high volatility premium can be captured. If the stock then goes up, while volatility goes down, the investor can sit and wait for a fine profit at expiration.

    If the stock continues down, the lower leg can be rolled down, in effect collecting additional time premium. If there is some sort of floor due to excess cash, strong cash flow, etc., from there it's a game of patience, keep betting it goes up and collecting time premium.

    Holding a good amount of cash, I'm prepared to actually buy the stocks involved if they stay down. The vertical call spread is being used similar to selling just out of the money puts, but in a format that I find easier to deal with if the situation develops unfavorably.

    I'm looking to generate about 15% per year by these tactics, more if the market will provide better opportunities. That would mean a nice correction with an increase in overall volatility.

    Disclosure: I am long INTC, JBL, VSH, XRTX, CRUS, HLIT.

    Dec 28 8:26 AM | Link | 3 Comments
  • Corporate Profits Say Market Fairly Valued

    Since the financial crisis, I've used NIPA Corporate Profits as an indicator for the future value of the S&P 500 (NYSEARCA:SPY), with good results. This approach made me optimistic back in 2009 and has served me well over the past five years.

    Here's a chart:

    (click to enlarge)

    Other than the obvious over-valuation of the S&P 500 during the tech bubble, the two series have moved fairly close together. Over the last two cycles, Corporate Profits headed down before the market did, by a year or so, and during the recent recovery they have surged ahead of the index.

    Using a scatter plot, it's possible to develop a formula for the relationship:

    (click to enlarge)

    Applying the regression formula to the most recent data (2,126.6 for Corporate Profits with IVA and CCAdj), the indicated level for the S&P is 1,813, very close to where it is today. We're right where we should be, by this line of thinking.

    Investment Implications

    Corporate Profits as a percentage of GDP are as high as they've ever been. John Hussman and Jeremy Grantham have been calling for them to revert to the mean, which has yet to occur.

    I've looked at the issue several times, and my best guess is that margins will decline, but not to historical averages. There has been a secular change in the balance of power in favor of management and capital over labor, and that is unlikely to completely reverse. To the extent it does, it will be a positive for the economy. Consumer spending is 70% of GDP, and if they have more money to spend it will push the recovery into 2nd gear.

    The ownership of good quality, fairly valued equities makes sense here. Those who did not fully participate in the banner year 2013 (myself included) will do well not to chase at current levels. A 10% correction would be nice, just to restore a sense of reality and normalcy.

    Disclosure: I am long SPY.

    Dec 22 7:17 PM | Link | 4 Comments
  • Taking A Position In Jabil

    Jabil (NYSE:JBL) tanked on guidance for the next quarter, revenue to be down 25%. Part of that is the already known loss of the Blackberry account, the rest is due to their intention to divest part of their operations. They already have a buyer, and will be reporting results in discontinued operations pending the sale. That, and an unspecified customer is moving around a bit. They maintain the relationship is solid.

    GAAP earnings are 57 cents for the most recent quarter. Annualizing that to $2.28, I reduce it by 25% due conform to guidance, and arrive at normalized earnings when the smoke clears of $1.71. Applying a multiple of 12.5, I arrive at a target price of $21.

    Jabil has somewhat more debt than I prefer, but cash flow is substantially greater than earnings, a sign of strength as far as I'm concerned.

    With shares trading at $15.75, I bought a vertical call spread, the JBL Jun 2014 13/15, for a net debt of $1.39. The trade breaks even at $14.39, and can be adjusted depending on how the situation develops.

    This was done in the speculative portfolio, which consists primarily of vertical calls spreads, in the money, on tech situations. Most of them are relatively high beta and have excess current assets as a support to share prices. Jabil has the strong cash flow, as well as good growth expectations for the remaining businesses.

    Disclosure: I am long JBL.

    Tags: JBL
    Dec 18 9:53 AM | Link | Comment!
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