Active investment management wins again
This is a classic example with Alkermes, plc (ALKS) of an investing strategy which turns the "risk-terror" of price "volatility" into the productive work of being alert and using the disciplines of a clearly-stated (and followed) portfolio management strategy coupled with compounding of rewards.
It is not the only example, by far. During just this calendar period of December 17 to the present (May 3rd), Market-Maker Intelligence Lists have provided subscribers buy guidance to 20 stocks and ETFs each market day of the past 90 days or 1,800 choices. All were available in a timely, usable fashion to subscribers with target-sell price forecasts and explicit calendar-date holding period time limit suggestions.
During the same period, a total of 1,500+ prior potential position prospects reached closeout points, 73% of them earning profits, and 27% incurring losses. The winners profited at a rate of +25.6 basis points per day, while the losers lost at a rate of 16.3 bp/d. In combination, there was better than twice as much gain as loss.
The net of +25 and -16 or +9 bp/day is an annual rate of half the 19 basis points (hundredths of a percent) which equals a 100% gain or doubling of capital in a year. So, the current rate of net gain from the MM Intelligence Lists is about +50% a year, a pace which approximates what we have seen typically from such lists since the beginning of 2016.
Now, what about the ALKS current opportunity?
We seek wealth-building opportunities by making comparisons between the expectations for coming securities prices being made by well-informed, highly-motivated, essentially-involved participants in the transactions process. They are the experienced trading employees of market-making [MM] firms.
We let these folks draw their own conclusions about coming securities prices from their own due diligence reasons and from their basic fundamental research. We have them do the hard collective and comparative-minutia work, and we focus only on how well their past forecasts have worked out in specific securities prices of the subsequent few months of actual market transactions. We know they draw on the concerted worldwide 24 x 7 information gathering efforts of over 100,000 other firm employees.
We have been doing what we do daily for over two decades and have actuarial archives of the millions of outcomes. In earlier decades, our clients were institutional investors, but now, we choose to deal only with individual investors managing their own affairs. These are the individual investors which make up an important part of the Seeking Alpha readership.
Our comparative evaluations are based not on the financial and industry competitive facts made public to all investors, but on the securities-price-changing implications of the buying and selling intentions of major investment organizations. Intentions kept closely-guarded before being implemented because their knowledge by other investor-competitors would defeat or minimize the intended gains.
How do we know?
We come to know, in a usefully-general way, what are their intentions because of what information technology advances have done, and are doing, to securities-transaction markets.
Securities markets evolution has made possible the daily transactions of millions of trades in ownership of thousands of securities in relatively small shares lots and small capital value amounts. Such aggregate volumes are made possible by the automated handling and matching of buyers with sellers under standardized operating practices.
It works where small, standard actions are involved. It doesn't work where multi-billion-dollar investment portfolios require transactions of multi-million-dollar trade values in irregular-size share lots. Such trades can't be automated because big-volume buying and selling appetites are not usually waiting to be balanced anonymously and automatically.
Such trades must be negotiated between buyers and sellers with similar capacities and potential interests which may be adequately aroused within short (but not immediate) decision periods. Negotiated trades are usually arranged between one trade initiator and several responding participants, all brought together by a market-making agent firm.
The reality of the marketplace is that opportunities to connect equal-share volumes of buyers and sellers at one price satisfactory to all (a "cross" trade) at this scale are rare and infrequent.
What is common is that the trade is initiated by one institution and several others will respond with volumes which in the aggregate are somewhat shy of the initiator's aim. Then, to be able to "fill" the initiator-client's trade order, the MM may stop being just a trade agent and will become a principal in the trade to the extent of their "positioning" the imbalance at present. Later, that position may be unwound by the MM in ordinary "regular-way" trades.
But a "principal" position exposes the MM's involved capital to the risk of unwanted market price changes. That can be, and usually is, protected by a parallel "hedging" deal in equivalent and opposite derivative securities - futures, options, swaps, etc. The sellers of such protection usually are equally-well informed about the underlying subject security's coming-price prospects, at least at its likely extremes. The cost of obtaining desired price protection can define the extremes of prices which are being expected by protection buyers and sellers.
The cost of such a hedge is recognized as part of providing "market liquidity" and will be a part of the trade "spread" cost accepted (or rejected, killing the trade order) by the trade initiator. So, acceptance of the market liquidity cost is an implicit confirmation by the trade initiator of the reasonable price-range dimensions of the MM forecast community.
That is important since the relationships between the subject stock's market quote and the price range extremes have useful indications about coming prices of the subject stock.
The role of the Range Index
Analysis of the impact of market-liquidity negotiations on the prices of derivative-securities produces the implied forecasts of coming price extremes. That range of forecast price extremes defines the extent of price uncertainty for the subject stock. The current market quote splits the forecast range into upside and downside proportions.
Figure 1 provides the upside-to-downside prospects for major Biotech Developer stocks, as seen by the MM community.
(note: all materials from blockdesk.com have been approved for appearance in this article)
The numbered ticker symbols in the blue field are referenced by the corresponding numeric intersections of the green horizontal upside-scale potential prospective rewards and the red vertical price drawdown actual worst risk experiences. Best prospects on this map for a long investment position are down and to the right.
Alkermes, plc at  and Biomarin, Inc. (BMRN) at  show the most attractive long Biotech Developer positions to hold at this point. Which of the two may be the better depends on how likely are the Figure 1 outcomes to occur. That may be more comfortably determined from Range Index histories.
The Range Index's measured value is the percent of the full MM price forecast range which is below the current market quote.
Histories are kept of subsequent price movements for each stock at all different levels of the Range Index [RI]. Their outcomes tell how likely and to what extent prices are likely to be reached following RI forecasts at a particular level (like today's). Comparisons between RI outcome histories provide a far better guide to what prices may be coming for different securities than by looking at Price/Earnings ratios.
Figure 2 shows how ALKS price range forecasts (the vertical lines) have trended in the past 6 months. The row of data below the picture contains the current price range forecast and its Range Index. The row also contains the history of prior RIs of the past 5 years which have had similar RIs to today's.
This picture is NOT a "technical analyst's chart" of PAST ACTUAL price ranges. Look again. It is a picture of the FORECASTS OF LIKELY COMING price ranges. Forecasts inferred from the actions of MMs in protecting their own interests (not yours). There they are hedging the temporary commitments of the firm's capital they must make in competing with MMs from other firms to earn the advantageous position they are in.
They are not like the rest of their firm's employees who may be handed a prescribed script of attitudes for specific stock price "expectations". Scripts which will help their employer unload or cover inventory positions no longer desired. Instead, these forecasts are as close to truthful, well-educated guesses about the future as are possible. Possible in as dynamic, volatile, and complex a situation as can be found outside of a raging military war.
MMs are the (legitimate) peacetime poster-children for decisions-under-uncertainty. Their personal compensations are emblematic of the trade-off between risk and reward. Skill in that role can make an easy target of retirement - without any further lifetime financial concern - by or before age 30.
But a couple of bad mistakes can find you out on the street before the day's market close, branded as an industry pariah, with anticipation of a lifetime Burger-King-server career. Century-old firms have been put in bankruptcy by bad-actor MMs.
How do porcupines make love? Very carefully.
Survivor MMs court uncertainty (where the biggest payoffs are) with experienced arbitrage skills. They intuitively engineer hedge deals in and across derivative markets. Deals where the odds of positive payoffs favor them. They also arrange structures which provide escape paths in case surprises arise.
The initial appearances of the hedges may appear to offer larger payoffs that are needed, but the MMs have an advantage not regularly available to or used by the public individual investor. They keenly recognize the power of TIME and are constantly present in markets where they can adjust between alternative actions when time (or lack of it) provides a beneficial (to their position) opportunity.
What we see of forecasts in Figure 2 -- as substantial upside price change opportunities - may rarely get fully exercised by market pros because a more favorable interim opportunity path occurs. Those vertical-green-line entry invitations into ALKS positions in early November 2018 may have been significantly satisfied in a week or two as client trade orders to buy the stock diminished or disappeared. If so, the MMs exit and move on to other more currently attractive (profitable) playgrounds.
We and you lack the continuing presence of the MMs in markets but can use their forecasts as a substitute.
The mid-late January price advances in ALKS (the large white end-of-day-price dots in each vertical bar) tickle the tops of the mid-late December forecasts, closing out several of the positions initiated by those forecasts according to our TERMD portfolio management discipline. Its rule uses the top of the forecast range as a sell target. The later forecasts now are known and in late March and early April become resolved as profitable closed positions.
We do not advocate daily trading in stocks because of the attention and personal time required. But the simplicity of TERMD allows positions to be ENTERED at points in time WHEN uncommitted capital availability needs to be put to work and the interesting stock's past history suggests there is a confluence of profitable odds and payoffs. Exits are simple with standing GTC (good till canceled) sell orders at sell targets or at holding period time limits (3-months from the forecast date). No daily sell monitoring is required because the broker will notify you of position closeout actions.
This approach urges the investor to spend most of his/her stock investment efforts at position entry. Guidance in making choices can come from the MM community's constantly-updated price limit expectations. For comparison purposes the MM's past forecasts having upside and downside price-range proportions like those of the present are reviewed in a row of data under the daily price range forecasts picture of Figure 2.
Today's ALKS forecast of a possible coming high (sell target) of $33.82 is a +18.5% advance from Friday's close of $28.54. The whole forecast range from $33.82 to $28.84 is above the current market quote of $28.54. That difference between the quote and the range low is another -5% of the whole forecast range, making ALKS' Range Index [RI] a -5.
That additional -5 is a fairly infrequent occurrence for this stock. In the past 5 years or 1261 market days, it has been seen (the Sample Size) only 10 times. The small (thumbnail) blue RI frequency distribution at the bottom of Figure 3 indicates how extreme is today's RI forecast of 5.
We use the RI to select prior days' forecasts using TERMD as a portfolio management discipline to see how well the MM community has projected portfolio position outcomes. We find that an ALKS RI of -5 has produced profitable outcomes with odds of 9 out of 10. A larger sample of prior RIs would be more convincing, but being at the extreme of multi-year experiences urges further reassurances.
They are provided in Figure 3.
source: blockdesk.com, Seeking Alpha, Yahoo Finance
The table of Figure 3 duplicates the data row of Figure 2 from columns [A] to [N]. [N] is that Credibility Ratio whose calculation is just described. Only one alternative stock, CELG, had a stronger payoff credibility ratio, and it is based on performances only one-fourth the size of ALKS.
In addition to the Win Odds of 90 for ALKS, the current-day payoff forecast provides some more credibility. ALKS upside sell target is +18.5%, while its average net TERMD outcomes from all 10 prior forecasts are +18.3%, including the one loss. This produces for ALKS a credibility ratio of 1.0, while most other biotech developer stocks prior forecasts like today's produced net gains of far less.
BMRN, the closest reward-to-risk tradeoff competitor to ALKS in Figure 1 shows here a credibility ratio of only .37, from an upside forecast [E] of +21.4% but a Realized Payoff [ I ] of only +7.9% (from prior [G] RIs in [L] ). Not encouraging.
Figure 3 shows other comparative measures of importance to most investors. In addition to the prior-RI Payoff realizations [ I ] it tells in [H] what proportion of the [L] priors had profitable outcomes. The complement of [H] (1- H) is used in [P] to probability-weight today's RI worst-case price drawdowns in all [L] prior experiences.
The [P] values are combined with [H] weighting of [ I ] payoffs in [O] to get in [Q] an odds-weighted net "figure of merit" useful in ranking at least one measure of logical attractiveness across all of the likely alternative investment candidate choices shown in Figure 3.
For those of a financial-engineering bent, the Net data of [Q] is combined with the average holding period time investments of [ J ] to produce the basis points per day measure [R] often used in capital investment analyses to indicate degrees of preference possible in CAGR rates of reward between capital commitment choices. A choice which can maintain a 19+bp/day payoff for a year doubles the in-hand capital or a CAGR of +100%.
Figure 3 has been ranked (among biotech stocks) on column [R], where ALKS is the stand-out leader. Even over the current average bp/day prior productivity of the 20 best equity securities from an over 2,700 population of MM-hedging-based price-range forecasts.
Why bother with all these calculations?
We bother for the same reason conventional investment analysts want to know as much as they can about the competitive capabilities and positions of the companies in which they may invest - to reduce uncertainties about potentials for capital (and time) losses.
Much of the readily-available minutia of industry-competitive uncertainty is already well-known at the time of capital-commitment decisions. All but what may seriously impact the essential score-keeping investment measures: the prices likely to occur in coming investment position holding periods.
Conventional procedures, such as P/E analysis, are usually done crudely, with erroneous forecasting methods. Look-back histories of prices resulting after the fact typically have little useful future information. But most investing tends to ignore what was being expected before the facts of capital commitment.
Other look-backs are typically offered including historical periods containing circumstances highly unlikely to occur during the coming period of concern to the investor and forecaster. That kind of broad-gauge approach typically produces useless information.
The few forward-looking "assists" are typified by "street" analysts' single-point price one-year "Target Estimate" shown in column [U] of Figure 3, taken from Yahoo Finance's Summary page for most stocks. The implied percentage change to "Target" from present price is in [V]. Back history on "Target" achievements and fails-to-achieve are never presented.
The notions embedded in blockdesk.com price-range forecast comparisons in Figure 3 columns [G] to [R] are nowhere to be found in publicly-available investment information sites like Yahoo Finance and others. Partly this is because it takes a lot of work to build and maintain them, and partly because the source data to feed them has not been collected and retained.
Some of the most basic information can be gleaned directly from historical prices. For example, a worksheet analysis (not shown here) of just closing prices on ALKS tells that over the stock's entire lifetime its average range of extreme prices during all 3-month (overlapping) holding periods have been 28.2%. Similar one-year holding periods have seen 89% ranges of price change - on average. Largest one-year ranges have been twice the 89%, and smallest has been one third, only 25%. Stock price histories are very "noisy" - variable.
Yet average "street analyst" forecasts of target prices at ALKS are for increases of +18% from the $28.54 to $33.67 during the coming year. The opportunity for error is enormous, yet the means of reducing the estimate error are typically never presented. That makes the likelihood for improvement by conventional methodology pretty small.
The average MM forecast for price extremes at ALKS within a 3-month holding period is only 20.4% over a nearly 2,000 set of daily-overlapping periods. Perfect capture (never expected) would inflate the 20.4% to an annual rate of 101% CAGR. Not all that different from the actual historical one-year range extremes of 89% over the same period.
So the MMs are not living in a different world than reality. Street analysts seem to be.
They (the MMs) just have a better hold on that "real" world than do their big-money investment organization clientele. And probably, than do most individual investors. The earlier ALKS MM potential forecast capture of +46% from 3 trades in less than 8 months is a good example of the power of compounding effective decisions.
Once again it appears that Alkermes, plc may provide an outstanding capital gain opportunity for investment portfolio wealth-building within reasonable expectations for risk exposure conditions.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ALKS over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: Peter Way and generations of the Way Family are long-term providers of perspective information, earlier helping professional investors and now individual investors, discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family but do provide pro bono consulting for a limited number of not-for-profit organizations.
We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So, our information presents for D-I-Y investor guidance what the arguably best-informed professional investors are thinking. Their insights, revealed through their own self-protective hedging actions, tell what they believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided in the SA blog of my name. First months of 2019 to date have produced over 900 hundred profitable position closeouts.