Posted on

Rolling the Dice with Earnings

With earnings season ready to begin its second full week there are again some opportunities to identify stocks whose earnings may represent risk that is over-estimated by the options market, yet may still offer attractive premiums outside of the presumed risk area.

While in a perfect world good earnings would see increased share prices and bad earnings would result in price drops, the actual responses may be very unpredictable and as a result earnings reports are often periods of great consternation and frustration.

For the buy and hold investor, while earnings may send shares higher, this is also a time when paper profits may vanish and the cycle of share appreciation has to begin anew. Other than supplementing existing positions with strategic option positions, such as the purchase of out of the money puts, the investor must sit and await the fate of existing shares.

Occasionally, a covered option strategy, either through the sale of puts or buy/write transactions, may offer opportunity to achieve an acceptable return on investment while limiting the apparent risk of exposure to the large moves that may accompany good, bad or downright ugly news. Although a roll of the dice has definable probabilities, when it comes to stocks sometimes you want something that seems less predicated on chance and less on human emotion or herd mentality.

As always, whenever I consider whether an earnings related trade is worth pursuing I let the “implied volatility” serve as a guide in determining whether there is a satisfactory risk-reward proposition to consider action. That simple calculation provides an upper and lower price range in which price movement is anticipated and can then be compared to corresponding premiums collected for assuming risk. It is, to a degree based on herd mentality in the option market and has varying degrees of emotion already built into values. The greater the emotion, as expressed by the relative size of the premiums for strike levels outside of the range defined by the implied volatility the more interested I am in considering a position.

My preference in addressing earnings related trades is to do so through the sale of put contracts, always utilizing the weekly contract and a strike price that is below the lower range defined by the implied volatility calculation. Since I’m very satisfied with a weekly 1% ROI, I then look to find the strike level that corresponds to at least a 1% return.

While individuals can and should set their own risk-reward parameters, a weekly 1% ROI seems to be one that finds a good balance between risk and reward, as long as the associated strike level is also outside of the implied volatility range. If the strike level is within the range I don’t assess it as meeting my criteria. I sometimes may be less stringent, accepting a strike level slightly inside the lower boundary of the range if shares have already had some decline in the immediate days preceding earnings. Conversely, if shares have moved higher in advance of earnings I’m either less likely to execute the trade or much more stringent in strike level selection or expecting an ROI in excess of 1%.

While conventional wisdom is to not sell puts on positions that you wouldn’t mind owning at a specified price, I very often do not want to own the shares of the companies that I am considering. For the period of the trade, I remain completely agnostic to everything about the company other than its price and the ability to sell contracts and if necessary, purchase and then re-sell contracts repeatedly, until the position may be closed.

However, for those having limited or no experience with the sale of put contracts, you should assume a likelihood of being assigned shares and the potential downside of having a price drop well in excess of your projections. For that reason you may want to re-consider the agnostic part and be at peace with the potential of owning shares at your strike price and helping to reduce the burden through the sale of calls, where possible.

Since my further preference is to not be assigned shares, I favor those positions that have expanded weekly options available, so that there is opportunity to roll contracts over in the event that assignment appears likely using a time frame that offers a balance between return and brevity.

This week there are a number of stocks that will release quarterly earnings that may warrant consideration as the reward may be well suited to the risk taken for those with a little bit of adventurousness.

A number of the companies highlighted are volatile on a daily basis, but more so when event driven, such as with the report of earnings. While implied volatilities may occasionally appear to be high, they are frequently borne out by past history and it would be injudicious to simply believe that such implied moves are outside the realm of probability. Stocks can and do move 10, 15 or 20% on news.

The coming week presents companies that I usually already follow. Among them are Amazon (AMZN), Cliffs Natural Resources (CLF), Cree (CREE), Deckers (DECK), Facebook (FB), Gilead (GILD), Microsoft (MSFT) and Netflix (NFLX).

The table above may be used as a guide for determining which of these stocks meets personal risk-reward parameters, understanding that re-calculations must be made as share prices, their associated premiums and subsequently even strike level targets may change.

While I most often use the list of stocks on a prospective basis in anticipation of an earnings related move, sometimes the sale of puts following earnings is a favorable trade, especially in instances in which shares have reacted in a decidedly negative fashion to earnings or to guidance.

Regardless of the timing of the sale of puts, before or after earnings are released, being more pessimistic regarding the potential for price drops may be an enticing trade for the generation of income.

Posted on

The Dark Side of Crowd Sourcing

(A version of this article appeared in TheStreet)

Crowds can certainly be a means for achieving good ends. Ask people in Tahrir Square or those in Kiev, although some may disagree and see only the dark side of crowds.

The power of crowds has made Wikipedia an increasingly legitimate asset as the crowd has been tamed and made to adhere to standards. The burden of creating a useful utility is borne by so many people that no one individual is critical and no one individual can harm the foundation.

In the world of financing “crowd sourcing,” the mechanism of pooling funds from a large group of people to help achieve an objective is getting increasingly popular for charitable and commercial ventures and received great fanfare this week as legendary musician Neil Young sought funding for his project of creating a high fidelity system to play and listen to digital music that restores all of the sounds and nuances of the original recordings as intended by the artists.

Neil Young has been adamant over the years about his feelings regarding the quality of the most prevalent file format used for digital recordings and many believe that the iTunes franchise of Apple (AAPL) is most at risk for an assault against that format and to introduction of a new audio player. Perhaps the sentiment attributed to Young that the songs on an iPhone “sound like crap,” and that even Steve Jobs wasn’t satisfied with the sound of music on the iPod, add to that feeling of an impending assault on the existing Apple eco-system..

As an artist proud of his art, and together with a growing collection of other well known artists who feel similarly about the preservation of the quality of their art, there is certainly a case to be made for providing a medium that faithfully recreates the experience. Of course, doing so requires capital and investment and is faced with long odds when the competitor is Apple.

While there are different models of crowd sourcing, the most commonly used and the one that Mr. Young is utilizing is that promoted by Kickstarter. It is one that offers rewards for contributions toward reaching a specified financial objective. Rewards are based upon the level of donation, which is referred to as a “pledge,” which is returned if at the end of the campaign the financial objective is not met.

As an example, a $5 pledge to this campaign entitles the donor to “LOVE + THANKS” and a mention on the website. Greater amounts may result in “swag,” including T-shirts, signed posters and even a discounted price on the music player. At the highest level, $5,000, donors receive a “VIP Dinner and Listening Party with Neil Young.”

No doubt that all of these reward have some value, but what they belie is greed.

First, Kickstarter offers a great opportunity for those without ready access to capital and a wonderful means to generate financial support for what may be great projects, products and ideas that would otherwise never see the light of day. Crowd sourcing may be the mechanism by which yet another great American success story is launched without the potential burden of over-bearing and demanding investors worried about their capital investments.

The alternative, the more traditional route is to access capital markets or venture capital and accept the potential liabilities that may come along with those alternatives. Whether that includes the re-payment of business loans or the granting of equity, the price is very tangible, although perhaps necessary and even an indispensable part of the equation.

The novice inventor has little chance to access either of these traditional routes of funding, having neither their own capital nor networks to get a foot in the door. That is where Kickstarter comes in and offers an opportunity to open the doors with very few strings attached other than a token gift of appreciation. That opportunity can make all of the difference for so many, but seems inherently wrong when the ones asking for pledges have infinite avenues available to them and are more likely to find the path to success to be a paved road.

And then there’s Neil Young.

While I’m not privy to his ability to personally finance this laudable project it may be reasonable to believe that through his own resources or through his personal network of contacts he would be able to find the resources necessary to bring this project fully into being. There is, however, scant information on the Kickstarter site as to the earlier backers of this effort.

In the event that there is a gap in funding for additional components of the strategy to bring the enhanced music player to market, there is clearly a downside to going back to original investors. That downside is the need to cede further equity to attract funds. However, the non-traditional route offered by Kickstarter entails none of that need to reduce personal equity. Instead yoou keep it all and pass the costs down to those who get no share in any potential future success.

In this case the objective of the campaign was to raise $800,000 which seems like a small amount, although there’s no indication of just how much has already been invested in the project. That $800,000 threshold was easily surpassed in just the second day of the campaign. In fact, it was more than doubled with more than a month remaining to collect even more.

Like the duo in “The Producers” the campaign can keep collecting as much as it wants because all that needs to be done is to print more T-shirts or sign more posters. As opposed to 100% of the pie the universe of T-shirts is conceivably unlimited and carries no future obligation to any of the donors.

Donors, many of whom, like me, probably already have a large collection of rock and roll T-shirts just love the idea of being associated in perpetuity with one of their favorite rock stars. In that case of the 8300 such items to be given away 5741 potential items still remain with an additional donation value in return of over $2.2 million. Of course, there are also those unlimited donor levels of $5 and $50, because “LOVE AND THANKS” is in eternal supply.

On the other hand, the cynic in me wonders how $800,000, in a project of this size could possibly have made any difference, particularly when access to real investors shouldn’t be a limiting factor. One has to wonder whether the campaign is simply part of an awareness and publicity campaign, as it has certainly already achieved quite a bit of attention in addition to money and helps to create a potential audience for the planned new hardware, made a bit more enticing with donor discounts.

No matter what your opinion this campaign will be an example of the power of crowd sourcing and will serve as a model for others eager to protect their own interests and perhaps drain from the pool of donations availabl
e to others less well connected to capital sources.

Too bad, but at least for the artist, if successful, it means hearing his work in the manner in which it was intended. For the donor who received a discount on the player it’s more likely a situation of wondering when he was going to hear the difference and how many washes that T-shirt can endure.

Posted on

Profiting From Good Fortune Or Bad

While most of the more meaningful companies in the S&P 500 have already reported earnings and new earnings season is barely 7 weeks away, there’s still time to profit from remaining earnings reports coming this week.

Whether a company’s shares respond to earnings by going lower or higher there is often opportunity to profit from either the good or the bad fortunes that they may endure as a result of their past performance and outlook for future fortunes.

As always, whenever I consider whether an earnings related trade is worth consideration I let the option market’s measure of “implied volatility” serve as a threshold in determining whether there is a satisfactory risk-reward proposition. That simple calculation provides an upper and lower price range in which any anticipated price movements will be contained.

Occasionally, for those selling options, whether as part of a covered call strategy or simply through the sale of puts, there may be an opportunity to achieve an acceptable premium even though it represents a share price that is outside of those bounds set by the option market.

This week there appear to be a number of stocks preparing to release their quarterly earnings that may warrant some attention as the reward may be well suited to the risk for some.

A number of the companies that I’ve highlighted are volatile in their own rights, but even more so when event driven, such as before earnings. While the implied volatilities may sometimes appear to be high, they are frequently borne out by past history and it would be injudicious to simply believe that such implied moves are outside the realm of probability.

While individuals can certainly set their own risk-reward parameters, I tend to look at a weekly 1% ROI as meeting my threshold on the reward side of the equation. I measure the degree of risk as whether I need to look above or below the implied volatility to achieve that desired return for what is anticipated to be a week’s investment.

Satisfactory risk exists when the strike price necessary to achieve the ROI is outside of the range predicted by the option market.

The coming week is replete with earnings reports and presents more companies than I usually find that satisfy the above criteria and are in companies that I usually already follow. Among the companies that I am considering this coming week are Abercrombie and Fitch (ANF), Best Buy (BBY), Deckers (DECK), JC Penney (JCP), Macys (M), salesforce.com (CRM), SolarCity (SCTY), Soda Stream (SODA) and T-Mobile (TMUS).

Since the basis of these trades is purely upon what may be considered an inefficiency between the option premiums and the implied volatility, I give no consideration to fundamental nor technical issues. However, my preference, when selling put contracts is to do so when shares have already been falling in price in advance of earnings. As the current week came to its end that included JC Penney, SolarCity, Deckers and Best Buy, although the coming week may define other possibilities.

For those not having sold put contracts in the past, one caveat when considering such trades, is that the investor must be prepared to own the shares if assigned or to manage the options contract, such as rolling it forward, if assignment appears inevitable.

 The table may be used as a guide for determining which of these selected companies meet the risk-reward parameters that an individual sets, understanding that re-assessments need to be made as prices and, therefore, strike prices and their premiums may change.

While the list can be used on a prospective basis in anticipation of an earnings related move there may also be occasion to consider the sale of puts following earnings in those cases where shares have reacted in a decidedly negative fashion to earnings or to guidance.

While some believe in hitting someone when they’re already down, there can be much more satisfaction gained in giving them support in their effort to rise again. Inherently the sale of a put is a statement of bullish sentiment and there may be opportunity to make that expression a profitable one as the response of many when knocked down is to get back up again.

Whether prospective or reactive, there is always opportunity when big movements are anticipated, but not fully realized.

And if they are realized? Think of it as simply more opportunity for opportunity.

Posted on

Earnings Finally Matter

 
A couple of years ago I finally realized that I like earnings season.

Part of that realization was out of necessity as it seems that earnings season never ends, so it just can’t be avoided. Of the companies that I regularly follow, no sooner does LuLuLemon Athletica (LULU) report its earnings that Alcoa (AA)traditionally kicks off the next season just two weeks later.

The way I now look at things earnings season accounts for about 85% of the year, so it has become a case of just learning to live with it instead of fearing the potential for swings. The problem with a buy and hold approach is that the investor is often held hostage to the wild price swings that accompany earnings and can see paper profits quickly erased as the mountain has to be newly re-climbed.

One of the nice things about using a covered option strategy is that you can, to a degree, determine what your exposure to earnings risk or reward is through the use of varied expiration dates. For existing holdings that you believe may have difficulty withstanding an earnings report the use of a longer option contract can give you more downside protection due to the larger premium, as well as additional time for shares to recover, if indeed they fail to hold the line.

You can also use shorter term options in the hope of being assigned out of a position in advance of earnings.

Of course, there is the more adventurous route, akin to being a storm chaser. You can meet earnings head on and purposefully trade in a stock just for the earnings related move.

While there are many ways to do so, I prefer the sale of out of the money put options and use the “implied volatility” as my guide, along with my objective of a 1% ROI on an investment that is hoped to last only for the week. Where possible I try to find a strike price that is outside the range suggested by the implied volatility, yet still offers a 1% or greater ROI.

Generally, only stocks that ordinarily trade with a high degree of volatility will be candidates for such an earnings related trade and have exhibited very large earnings related moves in the past.

This coming week is going to be a busy one as far as high profile companies go that may fit the above criteria. Among the companies that I am considering this coming week are Apple (AAPL), Amazon (AMZN), Blackstone (BX), Chipotle Mexican Grill (CMG), Facebook (FB), Las Vegas Sands (LVS), MasterCard (MA), Phillips 66 (PSX), Seagate Technology (STX), VMware (VMW) and Yahoo! (YHOO).

One thing that really appeals to me about earnings season is that it’s a time that I don’t really think about macroeconomic nor microeconomic issues. I simply focus on the numbers and the past history of price movements in that particular stock, especially in the aftermath of previous earnings reports.

The ultimate question is distilled to a very simple core. Is there an indication that the potential reward is sufficient for the potential risk?

As a general rule my preference is to sell puts when there is already an indication of price weakness. I look at any decline in share price in advance of earnings to be similar to a down payment and the sentiment that evolves as shares are already moving lower is often to increase the premium that can be obtained for the sale of puts and may also allow the use of even lower strike prices while getting a relatively larger option premium. Following this past Friday’s (January 24, 2014) 300 point loss in the DJIA, that isn’t terribly difficult.

The caveat is that you must be either willing to own the shares if assigned or be willing to manage the options contract until some resolution is achieved. That could mean rolling the option contract forward and hopefully to a lower strike or accepting assignment and then selling calls until assignment of shares.

The table above may be used as a guide for determining which of selected companies may meet the risk-reward parameters that an individual sets.

However, there are also times when, despite what appear to be acceptable rewards I don’t make the trade prior to earnings, but rather look for companies on the radar screen that find their shares on the losing end after announcement and guidance. That is especially true for those positions that don’t meet criteria or only do so marginally.

In such cases, I consider the sale of puts after the initial plunges, as often the premium is enhanced as sentiment assumes the importance that uncertainty previously held in maintaining the premium level.

Just a few days ago it appeared that the market was going to solely focus on earnings and fundamentals, just like in the old days. The coming week, in addition to perhaps being more responsive to earnings than in the past years, is suddenly also subject to many other winds, including more fallout from China, Turkish monetary woes, Argentinian debt and worries regarding the FOMC response to the current snapshot of the economy.

As a result, earnings related trades may also be impacted by those macroeconomic factors and I would be inclined to stay away from “marginal” selections and be increasingly inclined to consider trades after earnings, especially if prices have taken a strong downward move in response.

 

Posted on

Is Jeff Bezos Killing Capitalism?

(A version of this article appeared on TheStreet)
 

My guess is that if you asked people to describe the face of the individual most tied to the idea of destroying capitalism you would evoke images of Marx, Lenin or Castro, men of distinctive features and great bluster who made no secret of their disdain.
Ask me and I see a man who is softly spoken, clean shaved, spares the bluster, lacks distinct or memorable features, although possesses a distinctive laugh and has greatly benefited from the system he is destroying. I see Jeff Bezos as the anti-capitalist who is methodically destroying the foundations that allowed the United States to thrive.
First, let’s acknowledge that Amazon (AMZN) is an American success story. Financed by family funds and embracing technology as none had before, it survived an era that many did not and turned a concept into reality that has subsumed retailing, forcing retailers to create online shopping strategies.
Amazon will report its earnings on January 30, 2014. While I don’t invest with items such as P/E, in mind, I know enough that Amazon’s P/E of 1414 puts to rest the derisive comments about it being a non-profit. But I also know that no one believes in the axiom “we make it up in volume” more than Amazon, which had a 0.19% profit margin last year, compared to a sector average of 9.5%. Of 20 national retailers, only four had profit margins lower than Amazon; JC Penney, Sears Holdings, Best Buy and Aeropostale.
And that is precisely the problem. That is how Amazon is killing capitalism in its methodic march to eliminate competition, beginning with the already wounded. As the saying goes, “the market can stay irrational longer than you can stay solvent.” Bezos, though, isn’t being irrational, as demonstrated by competitors that are slowly melting into irrelevancy. With size comes power, in this case pricing power, which to a degree has been supported by an asymmetric application of sales tax collection requirements. In essence, indirect government support undermining existing capitalist structure in support of a venture evolving toward a monopolistic or market controlling position.
At a time when consumer discretionary spending doesn’t appear to be consistent with an expanding and improving economy price sensitivity remains an important motivator and Amazon maintains its advantage by aggressive pricing at the expense of margins. With over $70 billion in revenues it trails Wal-Mart, but exceeds the combined revenues of Sears, JC Penney and Kohls, while matching Target’s revenues. The latter two companies have scarce cushion in their profit and operating margins to withstand further erosion by an energized Amazon, ready to continue decreasing its margins, as it has done over the past 3 years.
AMZN Profit Margin (Quarterly) Chart
AMZN Profit Margin (Quarterly) data by YCharts
Don’t get me wrong. I am a capitalist through and through and believe that competition is what drives us forward, while other systems are left to the ash heaps of history along with the dodo. The same fate should befall businesses that simply can’t compete on the basis of that blend of price and quality that appeals to varying segments of the population.
Competing against Amazon, however, is somewhat like the Aztecs being faced with gunpowder propelled projectiles.
Admittedly, I shop Amazon and will probably continue doing so even as it increasingly loses the sales tax advantage it held over brick and mortar retailers. However, it is now that next phase, as that artificial pricing advantage disappears, that Amazon can only do one thing to maintain its position. It has to further reduce its profit margins.
While Bezos may not be acting irrationally, investors may be accused of doing so, particularly in light of margins. Most any other retailing CEO would have been shown the door with performance such as Amazon delivers. However, it’s share price that talks and you can’t argue with a P/E of 1414, except that it’s 1414. The realization that profits and return on equity are important concepts is currently suspended as there is implicit buy-in from investors that the strategy of driving the competition out of business is a sound one in anticipation of even greater share appreciation rewards. Clearly the vision of near monopolistic existence has its perceived reward.
While Amazon may not solely be to blame for the woes at JC Penney (JCP) and Sears (SHLD), it may not be entirely coincidental that JC Penney and Sears profit woes began in earnest at the time that Amazon’s own profit margins began decreasing in 2011. Amazon is undoubtedly a contributor not just to those growing losses, but also to the degradation of the shopping experience as so graphically illustrated in a recent series of articles by Rocco Pendola. When you can no longer compete on the basis of price and are unable to generate sales revenues and cash flows, the only recourse remaining is to cut costs.
Fewer employees, bare shelves and lack of facilities maintenance are the natural next stages. As predictable as the “Five Stages of Grief,” except there may be no end stage healthy resolution in sight.
While Bezos is on a path that endangers capitalism, his continued success may really jeopardize Amazon’s own shareholders whose fortunes are predicated on a model that history has shown can’t be sustained. Eventually, profits and not promises, are the engine that drive companies and their stocks. Sooner or later, cash flow is no substitute for profits.
If you want to see capitalism saved, the answer is a plummeting Amazon share price and subsequent investor pressure to increase profit margins, restoring balance to the retail sector and giving the likes of JC Penney and Sears the ability to dodge those projectiles.

Posted on

Taking Solace in an Earnings Challenged Coach

(A version of this article appeared in TheStreet)

It has been very easy to be disparaging of Coach (COH) these days.

In 2013, including dividends, an investment in Coach shares witnessed a 3.1% ROI, as compared to 29.6% for the S&P 500, exclusive of dividends.

Perhaps the root cause of the quantitative disappointment has been the near universal acknowledgement that Coach was no longer a very interesting place to shop, as Michael Kors (KORS) had displaced it in the hearts and more importantly, the literal and figurative pocketbooks of shoppers.

The first hint of trouble presented itself in August 2011 when shares plunged 6.5% after announcing earnings, following years of running higher, that took only a short rest in June 2010. While shares went bacl to their old ways of climbing higher under CEO and Chairman Lew Frankfort that climb came to a decided halt shortly after the Michael Kors IPO.

COH ChartIn 2013 Coach knew only large price moves following earnings reports, following the pattern that began in 2012. The difference, however, was that in 2013 all but one of those large price moves was higher, with -16.1%, +9.8%, -7.8% and -7.5% earnings related responses greeting increasingly wary and frustrated shareholders.

Coach reports its second quarter earnings on January 22, 2014 prior to the market’s open. The option market is implying a nearly 10% move upon that event, which comes on the heels of a 6.3% decline in shares in the past week.

For most, that may mean that this would be a good time to steer clear of Coach shares or even consider exiting existing psoitions, especially as the retail sector has been struggling to get consumers to part with their discretionary cash.

In the past year, while Coach has been a non-entity, I have owned it and sold calls on shares, or sold puts on eight occasions. Included in those trades were three sales of put options on the day prior to earnings and one purchase of shares and sale of calls on the day following disappointing earnings.

COH data by YCharts

During that time Coach has fulfilled two of my cardinal requirements in that it has been a model of mediocrity, but still has something to offer and will do more than simply make a pretense of maintaing a business model.

My goal with Coach, as with all positions upon which I use a covered option strategy is to make a small rate of return and in a short time frame. My ideal trade is one that returns a 1% profit in a week’s time and surpasses the performance of the S&P 500 during the time period of the trade.

During 2013, the cumulative return from the eight Coach trades was 25.4% and the average holding period was 28 days. The average trade had an ROI of 3.2%, which when adjusted for the average holding period was less than the 1% goal, consistent with the lower premiums obtained in a low volatiity period. However, during the same time periods for each trade, the results surpassed the S&P 500 performance for the same time periods by 18.5%.

Coach 2013 Performance - Option to Profit

While I don’t place too much credibility on annualizing performance, the annualized performace of Coach, utilizing the serial covered option strategy, with some trades timed to coincide with earnings was 41.5%, while the annualized S&P 500 return was 34.7%. A longer period of observation also yielded similar favorable results

In the case of potential trades seeking to reach those objectives when earnings are to be released, my preference is to see whether there is an option premium available for the sale of puts that is at the extreme end of the implied volatility range or beyond. For Coach, the implied volatility suggests expectations of a price move in the $47.50 to $57.50 range, based on Friday’s closing price of $52.56.

The $47 January 24, 2014 put premium satisfies the quest for a 1% return and is at a strike price slightly outside of the implied volatility range. Essentially, the risk-reward proposition is a 1% return in the event of anything less than a 10% drop in share price. Anything more than a 10% price drop creates additional possibilities to generate returns, but extends the period of the trade.

As always, the sale of puts should only be undertaken if you’re prepared to take ownsership of shares at the strike price specified. While I wouldn’t shy away from share ownership in the event of a larger than anticipated price drop, I would be inclined to consider rolling over the put sale into a new expiration date and ideally at a lower strike price, if possible, repeating that process until expiration finally arrives.

While not everyone appreciates leather, everyone can appreciate investment profits, even if they come at the expense of corporate losses and a fall from grace.

Posted on

Abercrombie and Fitch Sets Itself Up for More Disappointment

disappointment
 
(A version of this article appears on TheStreet.com)
With low expectations shareholders of Abercrombie and Fitch (ANF) were rewarded during Thursday’s after hours trading as it was announced that the company experienced higher than expected sales for the fourth quarter to date.
Embattled CEO and Chairman Michael Jeffries needed a boost after calls for his resignation and having been the recent recipient of Herb Greenberg’s “Worst CEO of 2013 Award.” The 15% surge, if maintained into trading to end the week will leave shares only about 30% below their 52 week high.
Perhaps lost in the translation are the nuances contained in the report that sent shares soaring that may set Abercrombie and Fitch share holders up for more disappointment in the future. Manufactured good news has a way of doing that once reality hits and it is difficult to interpret today’s press release as anything other than a very favorable spin on a company and a personality much in need of spin.
For the period in question, which ended on January 4, 2014, the company actually reported decreased total sales, but found some solace in the fact that its direct to consumer sales were at its highest level of total sales than ever before. Of course, as the total pie shrinks a component may look comparatively better by simply not shrinking as much. The details of the direct to consumer activities was lacking. Its growth, was by all accounts, relative.
While sales were reported to be better than expected they represented a 4% decrease in the United States and a 10% decrease in international sales. Improved guidance was based on the nine week period ending before much of the east coast freeze that is reported to have stalled mall traffic. It’s unclear how nature’s elements will project forward as the first quarter becomes the object of focus. Additionally, reliance on”ongoing cost reduction efforts” is rarely a strategy for growth. Jeffries’ one year contract extension may require something more substantive than smoke and mirrors to further extend the engagement. Marketing the company as “We’re Not Sears” is not likely to provide a prolonged bounce, much as today’s press release may be suspect.
But I don’t really care about any of that, because Abercrombie and Fitch, for all of its dysfunction and sometimes embaarrassing behavior of its CEO, has been one of my favorite stocks since May 2012. During that period of time I’ve owned shares on 18 occasions.
Abercrombie and Fitch hasn’t been a holding for the faint of heart during that period, nor for anyone abiding by a buy and hold strategy.
As a punctuated buy and hold investor, my sales have been dictated by the call contracts I routinely sold on holdings, almost always utilizing in the money or very near the money strike levels.
Abercrombie and Fitch
Perhaps coincidentally the average cost of those shares has been $38.64, which was just slightly higher than the after hours trading peak after its more than $5 climb. During the period in question shares were initiated at $35.15 and soared as high as $55.23 almost a year to the date of that opening position. A perfect market timer could have sold shares at the peak ans achieved a 59% return with dividends.
Not only am I not a perfect market timer, but I’m also not very patient and would have had a hard time holding onto shares for a full year. Instead my shares were held for reasonably short periods of time, other than one lot currently open for 4 months. During that time the cumulative return has been 56% while the shares themselves have appreciated less than 11% from the date of first purchase.
With some of my shares set to expire on Friday January 10, 2014 amd some others the very next week, there is a chance that I will be left with no shares, thanks to a well timed press release.
However, I have no doubts that Abercrombie and Fitch will find a way to undo investor goodwill and will see its price come down. When it does, I will be there, once again, eager to pick up the wounded shares of of a company that would be embarrassed to have me as a customer.

Posted on

When to Take Tax Losses

(A version of this article appeared in TheStreet.com).
Each year the ritual begins just days before New Years. Even in the best of years there are bound to be some losers. Fortunately, whatever faults there may be in the tax code, the ability to attenuate investment mistakes isn’t one of them.
Since I actively sell covered options and generate taxable premiums the thought of offsetting gains is appealing, but before jumping at the opportunity a grasp of history may be helpful.
In this case looking at the strategic tax losses taken in 2012 I’m struck by one thing. Four out of the five such sales saw shares appreciate more than the S&P 500’s gain for 2013. Not only did they gain more than 29% from their sales price, but they also gained more than 29 % from their purchase prices.
Proponents of the “Dogs of the Dow Theory” would readily understand the phenomenon, as perhaps should serial covered option writers who repeatedly write options on the same stocks as their prices regularly go up and down, sometimes even to extremes, yet so often recover.
Given the choice between taking a tax credit or a stock loss or paying more taxes because of greater gains, I would take the latter every time. However, there is a preponderance of thought that losses should be taken if they reach the 10% level. For those believing in rules, this is a useful rule, if consistently practiced.
Unfortunately, there is no guarantee that proceeds from the sale of losers will be recycled into the shares of winners. Sometimes losers simply give way to other losers, as even well devised ideas don’t alwaysbear fruit. While hindsight often has me wishing I had cut my losses, the real battle is deciding whether to follow your humble or arrogant side.
The arrogant side believes it can re-invest loser proceeds and recover losses. The humble side wonders how someone so ill-advised and having made the original investment, then sat frozenly while shares plunged, could now suddenly be deft enough to select a winner, instead of inviting ruination once again.
It’s difficult to not take the humble side’s argument. Logic trumps hope.
The decision process as to whether to take tax losses begins with understanding your tax liability, which is related to your marginal tax rate. If in the highest Federal tax bracket, the short term rate on capital gains is 39.6%, although the rate varies from 10 to 39.6%.
Next comes a look at the probabilities of various outcomes and their respective benefits.
There is a 100% probability that the loss will decrease your tax liability, if you didn’t violate the Wash Sales Rules. It’s hard to beat those odds, but if you do buy and sell the same stock repeatedly, as I often do, the 30 day window on either side of your proposed trade can scuttle your strategy.
The next step takes some calculation.
As an example, I’m going to look at Petrobras (PBR) shares that I bought on January 7, 2013 at $20.05 and currently trading at $13.48. An advanced degree is mathematics is unnecessary to recognize that represents more than a 10% decline and would violate investing rules sometimes attributed to famed financier Bernard Baruch.
The potential tax benefit is based upon your tax rate and whether the holding is a short term or long term. As a short term holding the Petrobras position is entitled up to a 39.6% credit against capital gains, meaning that credit can be worth up to $2.60 per share.
While that is an objective calculation, the next step is entirely subjective and focuses on your assessment of the probability that Petrobras shares will add $2.60 to its current share price. How likely is it that shares will gain 19.3%?  While there may be be company specific challenges, as well as broader economic challenges to consider, one may be justified in wondering whether Petrobras will be this year’s Hewlett Packard (HPQ), which was a strategic tax loss that I mistakenly took last year and is up 99% YTD.
If you believe that such lightning may strike twice in a lifetime you may decide to roll the dice and surrender the certainty of a short term tax credit.
if your educated gamble is right, even at the new higher price yomay still qualify for a tax loss, however, you’ll find yourself looking at a much ower credit, if the short term loss becomes a long term loss. As a movie character once asked, “are you feeling lucky?” If you can generate some option premiums along the way you can make your own luck, but whatever the outcome, it is deferred to 2015, which may entail further opportunity costs.
Then again, just look at your losers from last year. Unlikely as it may have seemed, recovery wasn’t outside the realm of possibility.
Bottom line? Ask your tax advisor, but do so soon.
Posted on

When to Take Tax Losses

(A version of this article appeared in TheStreet.com).
Each year the ritual begins just days before New Years. Even in the best of years there are bound to be some losers. Fortunately, whatever faults there may be in the tax code, the ability to attenuate investment mistakes isn’t one of them.
Since I actively sell covered options and generate taxable premiums the thought of offsetting gains is appealing, but before jumping at the opportunity a grasp of history may be helpful.
In this case looking at the strategic tax losses taken in 2012 I’m struck by one thing. Four out of the five such sales saw shares appreciate more than the S&P 500’s gain for 2013. Not only did they gain more than 29% from their sales price, but they also gained more than 29 % from their purchase prices.
Proponents of the “Dogs of the Dow Theory” would readily understand the phenomenon, as perhaps should serial covered option writers who repeatedly write options on the same stocks as their prices regularly go up and down, sometimes even to extremes, yet so often recover.
Given the choice between taking a tax credit or a stock loss or paying more taxes because of greater gains, I would take the latter every time. However, there is a preponderance of thought that losses should be taken if they reach the 10% level. For those believing in rules, this is a useful rule, if consistently practiced.
Unfortunately, there is no guarantee that proceeds from the sale of losers will be recycled into the shares of winners. Sometimes losers simply give way to other losers, as even well devised ideas don’t alwaysbear fruit. While hindsight often has me wishing I had cut my losses, the real battle is deciding whether to follow your humble or arrogant side.
The arrogant side believes it can re-invest loser proceeds and recover losses. The humble side wonders how someone so ill-advised and having made the original investment, then sat frozenly while shares plunged, could now suddenly be deft enough to select a winner, instead of inviting ruination once again.
It’s difficult to not take the humble side’s argument. Logic trumps hope.
The decision process as to whether to take tax losses begins with understanding your tax liability, which is related to your marginal tax rate. If in the highest Federal tax bracket, the short term rate on capital gains is 39.6%, although the rate varies from 10 to 39.6%.
Next comes a look at the probabilities of various outcomes and their respective benefits.
There is a 100% probability that the loss will decrease your tax liability, if you didn’t violate the Wash Sales Rules. It’s hard to beat those odds, but if you do buy and sell the same stock repeatedly, as I often do, the 30 day window on either side of your proposed trade can scuttle your strategy.
The next step takes some calculation.
As an example, I’m going to look at Petrobras (PBR) shares that I bought on January 7, 2013 at $20.05 and currently trading at $13.48. An advanced degree is mathematics is unnecessary to recognize that represents more than a 10% decline and would violate investing rules sometimes attributed to famed financier Bernard Baruch.
The potential tax benefit is based upon your tax rate and whether the holding is a short term or long term. As a short term holding the Petrobras position is entitled up to a 39.6% credit against capital gains, meaning that credit can be worth up to $2.60 per share.
While that is an objective calculation, the next step is entirely subjective and focuses on your assessment of the probability that Petrobras shares will add $2.60 to its current share price. How likely is it that shares will gain 19.3%?  While there may be be company specific challenges, as well as broader economic challenges to consider, one may be justified in wondering whether Petrobras will be this year’s Hewlett Packard (HPQ), which was a strategic tax loss that I mistakenly took last year and is up 99% YTD.
If you believe that such lightning may strike twice in a lifetime you may decide to roll the dice and surrender the certainty of a short term tax credit.
if your educated gamble is right, even at the new higher price yomay still qualify for a tax loss, however, you’ll find yourself looking at a much ower credit, if the short term loss becomes a long term loss. As a movie character once asked, “are you feeling lucky?” If you can generate some option premiums along the way you can make your own luck, but whatever the outcome, it is deferred to 2015, which may entail further opportunity costs.
Then again, just look at your losers from last year. Unlikely as it may have seemed, recovery wasn’t outside the realm of possibility.
Bottom line? Ask your tax advisor, but do so soon.
Posted on

2013 Strategic Tax Losses

It’s that time of the year to sadly sit and accept some reality and see if there are any strategic tax losses to offset trading gains. That is a gift in the tax code and just about the only thing that makes taking a loss palatable for me.

Before I go on, I’m not an accountant. I’m not even a Pediatric Dentist anymore. I’m not really certain what I am, other than to be someone faced with the same pragmatic issues as most investors, even in a year that everything seemed to just go higher and higher in share price.

Before considering what strategic tax losses I may decide to take this year, as the calendar is growing short, I find it useful to look back in time at the tax loss selections in 2012. .

The strategic tax loss sales I sustained last year were  on specific lots of Chesapeake Energy ($17.36),  Hewlett Packard ($13.66), ProShares UltraShort Silver ($51.09), Groupon ($4.79) and Potash ($40.07). The fact that other lots of those stocks may have delivered profits in 2012 is irrelevant and didn’t soothe the angst of parting under such sad circumstances. (CHK), (HPQ), (ZSL), (GRPN), (POT)

So where are they now after a year that has seen about a 28.5% gain in the S&P 500? Is there life after loss?

Their closing prices on December 24, 2013 were: Chesapeake Energy ($27.61), Hewlett Packard ($28.18), ProSharesUltraShort Silver ($90.02), Groupon ($11.83) and Potash ($32.82).

With the exception of Potash, all of those have had more than a 28% gain from their sales price and, in fact, more than a 28% gain from their purchase prices, as well.

The reason this isn’t too surprising is for the same reason that the “Dogs of the Dow” theory has been a reasonably reliable prediction tool. In general, if you invest in a company that isn’t likely to disappear in the near future or go bankrupt, there’s a very good chance that it will rebound strongly after a period of abysmal performance. Decent companies tend not to stay at depressed levels if the market around them is healthy. There are obviously exceptions to that generality, but how many stocks don’t display regular ups and downs in the charts, even to the point of periodic extremes?

Having looked, over about 30 years of investing results, very few “losers” failed to redeem themselves. That may be due in part to serendipity, but also from shunning really speculative issues. Back in the days when I had a stock broker, and I really did like and respect him, it was actually maddening to see how frequently stocks that had been sold for a loss had recovered. Given the choice between taking a tax credit or a stock loss or paying more taxes because of greater gains, I would take the latter every time.

However, my broker was a firm believer in taking losses if they hit the 10% level, which is a very traditional approach. To his credit, he followed his rules and was consistent in his application of those rules.

Consistency is what is ultimately one of the most important things when managing investments, even though there may be other paths to the same destination.

What I had also noticed was that there was no guarantee that the proceeds from the sale of losers past would then be recycled into shares of winners. Sometimes losers begat losers and sometimes losers begat winners. To a large degree the direction of the overall market was a factor in where individual stocks would go, especially if looking at an entire portfolio. However, even beautifully woven theses didn’t always go as envisioned and occasionally losses mounted, even though the intentions were honorable, but restricted by protocol.

In hindsight I always believe that when holding a loser I should have followed that 10% rule, but then you realize that the real dynamic at play is deciding whether to follow your humble or arrogant side into battle.

The arrogant side believes that it can take the money from the sale of a loser, re-invest it and recover the losses. The humble side wonders how it could be that someone so stupid as to have made the original investment in the first place and then watch it go down so much, could now possibly be smart enough to immediately pick a winner, instead of doing the same thing all over again.

For me, it’s hard not to take the humble side’s argument. Logic prevails in that argument over blind hope.

So where to begin?

Assuming that you are in the highest Federal tax brackets in 2013, the short term tax rate is 39.6%, although the rate will vary from 10 to 39.6% and doesn’t include state tax rates, if any. 

As always, your losses are limited to $3,000 in excess of your reported gains, with the ability to carry over additional losses to subsequent tax years. I’m desperately hoping that no one is reporting net losses, but rather looking to reduce their taxable liability.

That means that selling a losing stock gives you a credit against your gains, which includes option premium derived income, which is always taxed at the short term rate. If you do a lot of covered option selling you then may very well have a need or at least a desire to see whether there are any steps that can be taken to reduce your tax liability.

To make the decision of whether to take a strategic loss you have to look at the probabilities of various outcomes.

The first is the 100% probabil
ity that if taking the loss you will get a credit to your tax liability, subject to Wash Sales Rules. It’s hard to beat those odds, but if you do practice the serial kind of buy/write trades, as I often do, you also need to have a very good understanding of the wash sales rule and be very mindful of the 30 day window on either side of your strategic tax loss trade.

The next step takes some calculation.

As an example, I’m going to look at JC Penney (JCP) shares that I bought on July 30, 2013 at $16.16 and currently trading at $8.75. These values are not adjusted to reflect any option premiums collected. It doesn’t take a mathematics savant to know that is a loss well in excess of 10%. If Bernard Baruch were still alive he would slap me silly, as corporal punishment was still acceptable in his day.

The potential tax related advantage is based upon your tax rate and whether the holding is a short term or long term holding, with a one year period being the dividing line between the two. As a short term holding the JC Penney position is entitled up to a 39.6% credit against capital gains. In this case that credit can be worth up to $2.93 per share.

However, the next step involves the second probability in the equation. What do you believe is the chance that JC Penney shares will of their own trading add $2.93 to its current share price. How likely is it that shares will gain 33.5%? There may be company specific challenges, as well as broader economic challenges to consider. But there is also that thought that this could be the year to atone for past performance. Redemption, after all, isn’t limited to Hewlett Packard.

If you believe that may happen within your lifetime or an acceptable portion of that lifetime, you may decide to forego the certainty of a short term tax credit.

Similar considerations may be applied to shares of Petrobras (PBR) and Mosaic (MOS), both of which I’m considering selling for their tax benefits. However, as compared to JC Penney, the hurdle for price recovery to match the tax benefit is quite a bit lower, at 18.5% and 11.7%, respectively. 

Of course, if you’re right, even at that new higher price you can still qualify for a tax loss, however, you may find yourself looking at a much lower credit, if the short term loss becomes a long term loss. As Clint Eastwood might have said, “are you feeling lucky?” If you can grab some option premiums along the way you can help to make your own luck, but whatever the outcome, it is also deferred by a year to 2015, which itself may entail further opportunity costs.

Then again, just look at last year’s losers. Unlikely as it may have seemed at the time, recovery wasn’t outside the realm of possibility.



Bottom line? Ask your tax advisor, but do so soon.

 

Addendum:  An additional factor that I utilize in determining which losing positions to sell is related to another rule that I follow. That is the rule to not hold more than three individual lots of a specific stock. There is no hard science to that rule, but it is related to the desire to not have a specific stock be over-represented in the portfolio.

Occasionally, I will elect to sell a second or third lot of a specific stock because I believe there is greater opportunity for picking up replacement lots at lower prices (after the 30 day period required by the Wash Sales Rule has passed) and selling calls at the lower strikes, than there is in waiting for shares to rebound. In such cases I hope that the cumulative tax benefit and recurring option premiums on lower priced shares will be greater than the benefit derived from continuing to hold original shares.

That is why I included Mosaic and Petrobras shares in the illustrative table. However, individuals should look at their own annual profits and see which of their holdings may allow them the greatest certainty for benefit if sold for a loss, as compared to their own expectations for share price recovery. While JC Penney may be a strategic tax loss for one, it may not be so for another.

This year I will not make official “Tax Loss” sales recommendations, in recognition of the fact that some subscribers also have positions inside of tax deferred accounts. Additionally, as opposed to the past, I will continue, therefore, to follow those positions and track their performance.