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REHeakins
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Private Wealth Manager / Securities Expert / Co-host of "Investing and Your Legal Rights" heard monthly on www.KQV.com. Over 32 years in the investment industry, first working at PaineWebber for almost 20 years which included 3 years as a branch manager. Currently have a CRCP... More
My company:
OakTree Investment Advisors
My blog:
Covered Call Focus
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  • Buying Berkshire Hathaway Inc. And Selling A Covered Call

    03/31/14 Covered Call Pick: Berkshire Hathaway Inc. (BRKB)

    Berkshire Hathaway is an American multinational conglomerate holding company that oversees a number of subsidiaries that are involved and engaged in insurance, food service operations, energy distribution, manufacturing, and finance. Particularly known for Chairman, President, and CEO Warren Buffett, recognized as one of the most successful investors in the world, the company has produced a total return of 76% between 2000 and 2010, as opposed to the -11.3% produced by the S&P 500 over the same period, and has outperformed the S&P by an average of 25% during down years since 1965.

    BRKB has a market capitalization of $145.66 billion with 1.2 billion outstanding shares.

    BRKB currently pays no dividend.

    With a beta of 1.07, BRKB currently trades with approximately 7% more volatility than the current market.

    Our first Covered Call on Berkshire was way back in November of 2012, were we recommended a long-term out-of-the-money Call on Berkshire to generate income on a stock that represents some of the best management of any holding company on the planet. That strategy got called away in January netting us a 6.70% If-Called Return over the 417 days the strategy played out. While the stock rode the 2013 market higher, it has been consolidating since last June, and just recently broke out from its previous $119.30 high and entered a new buy phase.

    If you were crunching the numbers, you will see that if we had just bought BRKB without selling the Call, we would have made more money than we would have than using our Covered Call Strategy. But let's be clear here, the purpose of that strategy was to create income in a relatively low-risk equity position for people that require it. While Berkshire can be argued to be one of the best holdings one can have on the planet, and is headed by one of the most - if not the most - prolific investor the markets have seen, you do not buy Berkshire for explosive growth. While Mr. Buffett is obviously concerned about the growth of his company, his investment mindset is not a short-term one, but rather is quite far-seeing. The run the markets had in 2013 was spectacular, but is not "normal" for bull markets when related to the economic data we are seeing. Now that is all fine, as we are not concerned about the sky falling around us, but even so far this year we can see the increased volatility in the markets. 2014 is not another 2013, and while we still believe the market will be up by the end of the year, it always pays to be cautious and take the small profit instead of reaching for the larger one and getting burned.

    Investors' Business Daily classifies the current market as entering a correction phase due to the number of distribution days the market has seen. While we can't quantify how serious a correction this (though we expect at least one more serious correction by the end of the year) we are going to look for a slightly out-of-the-money Call. While on some stocks we would normally sell an in-the-money Call if we thought a correction was imminent, it is really hard to do that with a company like BRKB which is managed so well, has such a great, long-standing track record against the market, and has the near-term technicals to support a bullish move in the stock. Like we said though, it pays to be cautious and take some money off the table by getting a larger premium with a closer strike price for a conservative equity position in a stock that has a stellar track record in tough market conditions. That is why we are recommending buying BRKB and selling the September 2014 $125 Call.

    Scenario:

     

    • Buy 100 shares of BRKB @ $124.47 = $12,447 + Commission ($12.95) = $12,459.95
    • Write 1 BRKB September 2014 $125 Call @ $450 - Commission ($8.70) = $411.30

    Note: Prices may vary from the time of post. Actual commissions paid will vary returns.


    Static Return (Not Called):
    (Call)/Stock Price X (Days/Year)/Days to Expiration

    (4.11)/124.60 X (365)/173

    = 6.96% Static Return


    If-Called Return:
    (Call + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration

    (4.11 + 125 - 124.60)/124.60 X (365)/173

    = 7.64% If-Called Return


    Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.

    Posted by OaktreeAdvisors at 3/31/2014 9:55 AM
    Categories: Weekly Picks

    Previous Post

    Disclosure: I am long BRK.B.

    Additional disclosure: As active managers (OakTree Investmetent Advisors) may increase or decrease our position in BRKB as markets dictate.

    Mar 31 11:11 AM | Link | Comment!
  • Buy Grand Canyon Education Inc. And Sell And Out Of The Money Call

    03/24/13 Covered Call Pick: Grand Canyon Education Inc. (LOPE)

    Grand Canyon Education Inc. (LOPE) and its subsidiaries provide post-secondary education programs in the form of undergraduate and graduate-level college programs through its Arizona campus and online systems. With degree specializations in the area of education, healthcare, business, and liberal arts, LOPE services nearly 60,000 students throughout the United States and Canada.

    LOPE has a market capitalization of $2.2 billion with 46 million outstanding shares.

    LOPE currently pays no dividends.

    With a beta of 1.27, LOPE currently trades with approximately 27% more volatility than the current market.

    After a long break away from any stock picks, we're back and with a gem of a stock. LOPE is a for-profit university, which might be a weird concept for many who consider educational institutions like universities in the traditional sense. LOPE though is hardly traditional, as one of their best attributes as a business and a university, is the robust investment they have made in their online curriculum base. As our lives continue to become more and more digital, it only makes sense that the way we learn begins to trend in the same direction. Online programs give the opportunity for thousands of people that would otherwise not be able to get a post-secondary education, whether it be due to money, time, or location, the chance to participate in a goal and dream that many consider integral to our way of life. For LOPE, enrollment in 2013 rose by 14% to nearly 60,000 students, 90% were taking the online curriculum. The fact the university has such a robust online system for their classes (evidence by the fact that so many students opt for that method of learning rather than the more traditional classroom option) is a good sign that they are getting it right when it comes to way we will be learning in the next couple of decades.

    What we really like about the stock though are the numerous bullish metrics we see in both their business and their stock. Here is a list of what we see that we like:

     

    • Earnings have been positive and increasing for the last seven years with a 6300% increase between 2007 and 2013.
    • Estimated earnings increase for 2014 and 2015 are 9% and 13% respectively, representing a continuation of a long-term trend of profitability.
    • Return on Equity is 31%, nearly double the 17% metric Investors.com recommends as a minimum "buy" statistic.
    • 2013 revenue increased by 17% on the back of strong student enrollment, and is expected to continue to increase due to the strong online segment of the business and the long-term national trend for post-secondary educational enrollment.
    • Operating margin increased by 1.6% y/y to 25.5% off of increases in on-campus enrollment.
    • The number of funds owning the stock have increased 23% over the last year.
    • The Up/Down ratio on the stock is 1.4, showing a demand for the stock.
    • Debt-to-Equity is 0.3, in-line with the industry average.

    That is a lot of bullish statistics on a stock that most people probably didn't even know existed. The only things missing from this list for us would be a dividend that was steadily increasing, and a better valuation than the stock currently supports (P/E of 25, P/B of 6.4, an P/Sales TTM of 3.7), but you can't have everything.

    Technically, the stock formed a cup formation after failing to hold a huge bump from an earnings increase back in November. This formation finished in early January where it failed to break through its previous high and began a new cup formation that it finished at the end of February. The "handle" from this second cup has been forming over the past month. The purpose of this technical formation is to remove weaker holders of the stock while investors with more conviction and commitment hold on to the stock, forming a strong support base. These down days have showed lower than average volume, meaning it is only the these weak investors that are selling. The stock has shown that it has shaken out these investors and has begun to move higher to test the rim of this cup. If it breaks out to the upside, volume confirmation of 40-50% above the average should be enough gas for the stock to break out past its previous highs and continue unimpeded for a time.

    For a Covered Call Strategy on the stock we are looking for an out-of-the-money Call to take advantage of the strong fundamental and technical support the stock has. That is why we are recommending buying LOPE and selling the June 2014 $55 Call.

    Scenario:
     

    • Buy 100 shares of LOPE @ $47.37 = $4,737 + Commission ($12.95) = $4,749.95
    • Write 1 LOPE June 2014 $55 Call @ $100 - Commission ($8.70) = $91.30

    Note: Prices may vary from the time of post. Actual commissions paid will vary returns.


    Static Return (Not Called):
    (Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration

    (0.91)/47.50 X (365)/89

    = 7.86% Static Return


    If-Called Return:
    (Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration

    (0.91 + 55 - 47.50)/47.50 X (365)/89

    = 72.61% If-Called Return


    Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.

    Posted by OaktreeAdvisors at 3/24/2014 9:49 AM
    Categories: Weekly Picks

    Previous Post

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

    Mar 24 11:43 AM | Link | Comment!
  • Riding The Rail With Kansas City Southern (KSU)

    02/24/14 Covered Call Pick: Kansas City Southern (KSU)

    Kansas City Southern (KSU) owns and operates domestic and international railroad networks throughout the United States, Mexico, and Panama through a number of subsidiaries. Engaging in the freight rail transportation business, Kansas City Southern has railroads through important cities such as Kansas City, Missouri, and important shipping ports all along the Gulf Coast. Kansas City Southern is the only Class 1 railroad that owns track both inside and outside of Mexico's boundaries.

    Kansas City Southern has a market capitalization of $10.53 billion with 110.2 million outstanding shares.

    KSU currently pays a $0.215 quarterly dividend for a current yield of 1.2%.

    With a beta of 1.74, KSU currently trades with approximately 75% more volatility than the current market.

    You normally don't see names as volatile as KSU on our humble little blog when Monday morning comes around. If you looked at the stock chart's last couple years, you wouldn't see anything too rambunctious until you come to this past January. That is when a bill in the Mexican lower house was passed that threatens a concession that grants exclusive right-of-freight operations to KSU for 13 more years, with an option to renew for an additional 50 years. This concession led to 46% of the company's 2013 revenue, and with such uncertainty on the table, the stock gaped downwards by over 20%. Technically, the chart looks pretty horrible, with increased volatility in the wake of the bill and the stock's 50-day moving average dropping below the 200-day moving average (affectionately called the "Death Cross"). The stock bounced off the $90 level, but is still showing higher than average volume and uncertainty.

    That said, we still think that in the long term the stock and the company provide a great investment, and this recent drop in price can offer a great entry point.

    How competitive a railroad is, is directly related to the location of its assets - in other words, its rails. While most Class 1 railroads have routes spanning continents, KSU operates a smaller north-south route, but one that is no less important. Its central U.S. franchise consists of track owned in the Midwestern United States running from Kansas City to New Orleans, and then around the Gulf down to Mexico City. This route is placed to take advantage of Nafta trade, Mexican automobile and appliance production, Mexico's port traffic, and U.S. intermodal volume. KSU's compact size and strategic placement also make it the only Class 1 railroad that is a potential target for takeover without regulatory opposition. The company has had a history of lagging profits, but recently turned free cash flow positive with greatly improved margins including a 2013 operating ratio of 68.8%. The company also holds a wide economic moat according to Morningstar's research, due to their cost advantages and efficient scale. Quoting Morningstar's analysis on KSU:

    "While barges, ships, aircraft, and trucks also haul freight, railroads are the low-cost option by far where no waterway connects the origin and the destination, especially for freight with low value per unit weight. Moreover, railroads claim quadruple the fuel efficiency of trucking per ton-mile of freight, and thanks to greater railcar capacity and train length make more effective use of manpower despite the need for train yard personnel."

    Namely, railroads still provide the best way to ship large amounts of freight over land. In addition, they're nearly impossible to replicate. Another company can not just decide to start-up a railroad and lay thousands of miles of track across continents. The barrier to entry is high, which creates an amount of safety in KSU, despite the possible threat to the Mexico concession.

    Despite the uncertainty surrounding the Mexico concession, 2014 and 2015 earnings growth estimates are at 16% and 17% respectively, and is now trading below Morningstar's fair value estimate of $100. Because of the technical instability of the stock in the near-term, we are recommending a longer-term Covered Call strategy on the stock in order to remove near-term price fluctuations. That is why we are recommending buying KSU and selling the September 2014 $100 Call.

    Scenario:
     

    • Buy 100 shares of KSU @ $95.31 = $9,531 + Commission ($12.95) = $9,543.95
    • Write 1 KSU September 2014 $100 Call @ $570 - Commission ($8.70) = $561.30

    Note: Prices may vary from the time of post. Actual commissions paid will vary returns.


    Static Return (Not Called):
    (Call + Dividend)/Stock Price X (Days/Year)/Days to Expiration

    (5.61 + (3*0.215))/95.44 X (365)/208

    = 11.50% Static Return


    If-Called Return:
    (Call + Dividend + Strike Price - Stock Price)/Stock Price X (Days/Year)/Days to Expiration

    (5.61 + (3*0.215) + 100 - 95.44)/95.44 X (365)/208

    = 19.89% If-Called Return


    Disclosure: Clients and/or principles of OakTree Investment Advisors may or will have an investment in the above positions, but only on the the same sides of the trades. The above numbers are analytic estimations based on information known at the time of this post. OakTree Investment Advisors does not guarantee the above, or any, result. All investment decisions should be made based upon individual's personal investment goals and risk tolerance.

    Posted by OakTreeAdvisors at 2/24/2014 10:56 AM
    Categories: Weekly Picks

    Previous Post

    Disclosure: I am long KSU.

    Additional disclosure: As active managers we may add to or sell positions in KSU.

    Feb 24 10:15 AM | Link | Comment!
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