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Tom Armistead
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I am a retired accountant, having spent the early years of my career in the insurance industry and the later part in the field of accounting. My insurance experience has given me the willingness to accept investment risk if I feel the return justifies it; also, an interest in applying risk... More
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Tom Armistead's Instablog
  • Xerox: An Options Strategy In Response To Selloff 2 comments
    Jan 26, 2012 6:42 AM

    Xerox (NYSE:XRX) was hit by a brutal selloff in the wake of it earnings report, off 10% to $7.81. 2012 guidance works out to $1.00 GAAP, on a 2% increase in revenues, with cash flow of $2.0 to $2.3 billion, or $1.50 per share, much of it to be returned to shareholders.

    XRX spends 3% of revenue on R&D, and produces a substantial number of patents on an annual basis. Here's a link to a press release, providing some information on this function. Arguably, the future value created by this activity will eventually provide increased income to the shareholder. If not, the expense can be pared and EPS increased.

    The question on R&D is, where's the beef?

    Mr. Market doesn't seem to place much value on that $1 of earnings, or that $1.50 of cash flow. The company has now paid off the debt taken on for the ACS acqusition, and has no need to access equity markets for capital. In point of fact, buybacks are ongoing. Most of the remaining debt is related to financing customer purchases, a profitable activity. The actual cost of capital is very low here.

    The investor buying at today's price is getting an earnings yield of 12.8%, quite a bit higher than the 2% rate on ten year treasuries. The dividend, at 2.18%, is backed by share repurchases, as an additional return.

    A vertical call spread, long the July 6 call, and short the 7 call, can be done for 80 cents. Assuming the shares are above $7 at expiration, the return annualizes to 51%. This makes sense to me, as a way to cash in on market negativity.

    Disclosure: I am long XRX.

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Comments (2)
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  • Rookie IRA Investor
    , contributor
    Comments (2878) | Send Message
    Nice little play.When I saw Xerox was down, I was waiting for you to weigh in.
    26 Jan 2012, 07:37 AM Reply Like
  • Tom Armistead
    , contributor
    Comments (6225) | Send Message
    Author’s reply » At this point, on a lot of these value stocks, it seems like some form of collecting premium and agreeing to own the stock at prices in the area of a 52 week low is pretty attractive.


    Of course we could curse and swear later, after selling calls at some ridiculous strike and then the shares go up to $12 or $14. But 50% annualized looks pretty good.
    26 Jan 2012, 07:49 AM Reply Like
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