- There's much to like about this company, particularly the dividend history here.
- Investors don't buy companies, though, they buy stocks. In spite of the fact that an insider just bought a large block, the stock is a bit overpriced in my estimation.
- Thankfully, there's an excellent short options trade that presents investors with a "win-win" trade.
I decided to look at Spire Inc. (NYSE:SR) because utilities are relatively immune to economic downturns and because the company is a dividend superstar. I want to determine whether the shares represent good value at these levels or not. I'll try to answer that question by reviewing the financial history here, and by looking at the stock itself. Spoiler alert: In spite of the fact that an insider purchased just under $200,000 of stock, I don't think the shares represent great value at the moment, as they're slightly overpriced. That said, there is an excellent short put trade to be made here that I think has the potential to generate decent returns for investors. I don't like the current price, but there's obviously value here. For that reason, I think the best strategy at the moment is to eschew the shares but sell the puts.
There's much to like about the financial history here in my view. In spite of the fact that revenue has been basically flat for years, the company has managed to grow profits at a CAGR of about 5.5% over the past five years. In addition, the payout ratio remains muted, currently, at about 50% on both earnings and cash from operations. This suggests to me that there's little reason to worry about ongoing dividend payments here.
Nothing's perfect, though, and Spire is no exception. In particular, the level of debt has grown dramatically over the past five years, and, as a result, the interest expense has grown at a CAGR of about 6.5% in that time. Also, investors have been exposed to consistent dilution, so going forward, each share will likely represent a smaller portion of future earnings.
While the first quarter was a bit softer than the same period a year ago on a GAAP basis, I'm not particularly worried about an emerging trend. In particular, the company actually delivered improved economic earnings in the first quarter relative to the same period a year ago (from $66 million last quarter to $72 million in the most recent quarter).
I think the following slide from the latest earnings call captures the essence of why this is a reasonably attractive, if somewhat boring, company.
Source: Company filings
Unfortunately, investors can't simply buy into the cash flows of a given business that they find attractive. Most of us access the future cash flows of a given company via the public markets, and those are governed by very opaque rules all their own. The stock we buy and sell seems to move up and down dramatically in price based on little if any news. For that reason, I need to spend some time writing about the stock as a thing distinct from the business. As I review the stock, I'm attempting to answer one question: if I buy at current levels, will I be overpaying? The reason I want to understand whether I'm overpaying is that overpayment leads to future capital loss, and the nature of loss is such that we have to earn much higher rates of return in the future just to get back to breakeven. I determine whether I'm likely overpaying or not in a host of ways, ranging from the more simple to the more complex. On the simple side, I look at the ratio of price to some measure of economic value. Ideally, I want to see the shares trading at a discount relative to both the overall market and their own history. On that basis, it seems to me that Spire is somewhat expensive.
In addition, I think it's worthwhile trying to understand what the market is currently assuming about the future for a given enterprise. In order to do this, I turn to the methodology described by Professor Stephen Penman in the book "Accounting for Value." In the book, Penman walks investors through how they can isolate the "g" (growth) variable in a standard finance formula to work out what the market must be thinking about the future. Applying this methodology to Spire suggests the market is assuming a long-term (i.e. perpetual) growth of about 8% for the company, which I consider a massively optimistic forecast. For these reasons, I can't recommend buying the shares at current prices.
I should point out that just because I don't like the shares at current levels, there's an insider who just spent a sizable amount of money buying shares, suggesting that at least one of the people who know this business best anticipate future upside (from their purchase price at least).
I've written it before and I'll write it again. Investors aren't created equal. Some people are better at this activity because they're emotionally and intellectually more well-adapted than the rest of us. Some people succeed because they are institutional investors with legions of analysts at their disposal. Some people are very good at investing in a particular name because they work at that company and, therefore, know more about it than any Wall Street analyst ever will. I think we owe it to ourselves to be at least aware of the actions of insiders.
With that as a preamble, this past March, Treasurer Adam Woodward made two purchases of Spire stock. The first of these was on March 10th when he bought 1,400 shares. He bought another 1,400 shares two days later. All in, these purchases cost him just under $193,000. This works out to an average purchase price of $68.89 per share. In my view, when a person who knows this business better than anyone outside of the firm puts their own capital to work in the name, we should at least take note of it.
Options As Alternative
In my opinion, selling put options at a desirable strike price is a way to simultaneously invest while refusing to participate in an overpriced market for a security. This is why I consider selling puts to be superior to simply buying shares on a given day, and why I consider the short-put trade to be a "win-win" proposition. If the shares remain relatively expensive, the investor will simply pocket the premium, which is never a hardship. If the shares drop in price, the investor may be obliged to buy, but they'll be doing so at a price that they pre-determined was acceptable to them. Just because I don't happen to think Spire is a good investment at the current price, doesn't mean I don't think there is value here. I'd be happy to own the stock, just not at the current price.
With that in mind, I'd recommend selling some puts on the name at a net price that represents good value in my estimation. At the moment, I like the December puts with a strike of $65. These are currently bid-asked at $4.10-7. If the investor takes the bid here and is subsequently exercised, they would be purchasing about 15% below the current price. Holding all else constant, be exercised would mean that they would be buying these shares at a PE of 15.7 and a dividend yield of just over 4%. That's a level that represents a great opportunity for future capital gains, in my opinion.
We navigate our way through life by choosing between various imperfect options. Each option has its own combination of risk-reward tradeoffs, and the script of our life is the sum total of those decisions. The act of making investment decisions is a subset of this phenomenon. In the domain of investing, there's no risk-free option. There's risk a, and there's risk b. We do our best to navigate the world by exchanging one pair of risk-reward trade-offs for another. For example, holding cash presents the risk of erosion of purchasing power via inflation and the reward of preserving capital at times of extreme volatility. The risk-reward trade-off of buying shares is self-evident in early 2020.
Put options are no different in this regard. I've described the reward potential of these often, so I'm duty-bound to spend the rest of this section talking about the risks of selling puts. I think the risk profile of the short put is very similar to that associated with a long stock position. If the shares drop in price, the stockholder loses money and the short put writer may be obliged to buy the stock. Thus, both long stock and short put investors typically want to see higher stock prices.
Puts are distinct from stocks in that some put writers don't want to actually own the stock; they simply want to collect premia. Such investors care more about maximizing their income and will, therefore, be less discriminating about which stock they sell puts on. These people don't want to own the underlying security. For my part, I'll only ever write puts on companies that I'd be happy to own, at strike prices that represent good entry points for me. For that reason, being exercised isn't the trauma for me that is for many other put writers.
In addition, I think put writers take on risk, but they take on far less risk than stock buyers. Short put writers like me generate income simply for taking on the obligation to buy a business that they like at a price that they find attractive. This circumstance is objectively better than simply taking the prevailing market price. This is why I consider the risks of selling puts on a given day to be far lower than the risks associated with simply buying the stock on that day.
Since I've never passed up the opportunity to beat the proverbial dead horse, allow me to drill this idea into your head even further using Spire as an example. The investor can choose to buy the shares today at a price of ~$71.00. Alternatively, they can generate credit for their accounts by selling put options that oblige them - under the worst possible circumstance - to buy the shares at a net price 15% below today's level. In my view, buying the same asset at a 15% discount is the definition of lower risk.
I think there's much to like about Spire. The company has grown earnings and dividends fairly consistently over time, and I see nothing on the horizon to endanger the dividends at this point. The fact that the company has paid growing dividends for the past 17 years is also a plus. I also like the fact that an insider paid nearly $200,000 of his own money to buy shares at a price of $68.89. Unfortunately, shares are currently priced about 4.5% higher than Mr. Woodward acquired them at and, therefore, people who buy today will have a different long-term return from the shares than he will. This is a recurring theme in my writings. I like the business but I am nervous about the current price. Thankfully, the options market provides investors with the opportunity to receive a return immediately to take on the obligation to buy the shares at an even more attractive price than Mr. Woodward paid. While I can't recommend buying at the moment, I can suggest people sell the puts described above, as doing so leads to a "win-win" outcome in my view.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.
I'll be selling the puts mentioned in this article.
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