Trading Update 31/12/2016

Crude Oil

oct30-02

Regal Beloit

oct31-01 oct31-04

Gilead

oct31-05

Just want to go through some charts here for the 31 st of October. First of all, if we look at the chart of crude oil, we can see that the RSI indicator on a 5-day setting is about to get into oversold territory. Now, the difficulty here with oil is knowing where we are in this intermediate cycle. I definitely maintained that we printed an intermediate cycle low in August. The question remains whether we are still in the first daily cycle (as the lowest that we had in mid September was a half cycle low) or it was a daily cycle low which has basically disected the intermediate cycle thus far into two daily cycles. It can go either way because daily cycles in energy usually last much longer than daily cycles in equities, so getting long here would be pretty risky. Why? Because if this still is the first daily cycle, and if we are dipping down in to a daily cycle low, we still could have potentially $8 of potential downside to go…

I do not see us going through the lows that we printed in August but we could go to $41, $42, $43, so we are going to wait here for a while until we get long again. Sentiment is still pretty high in crude oil so I don’t like getting long at these levels. And as we’ve seen before even when the RSI indicator gets really oversold, it can stay like this for a good period of time. And while it’s oversold the price of crude can drop everyday so the best thing to do is to wait for a swing, wait for sentiment to reset and that will be the point to get long again –  basically the start of the next daily cycle.

The next chart I want to show you is of a company called Regal Beloit, ticker symbol (NYSE:RBC). Now the stock is not a large cap stock, it’s a mid cap stock. It’s announcing earnings next week. I wouldn’t play options on this stock for its earnings play because it’s not that liquid. You’re not going to get good fills. But what I would say is that this stock is very cheap compared to its historic averages. If we look at its price to earnings ratio, you are looking at a price to earnings ratio of approximately 18.5. You compare that to company’s 5-year average of 33.4, and straight away the stock sticks out to you as being pretty cheap. Its price to book ratio is 1.3, its price to sales ratio is 0.8, and its price to cash flow ratio is 6.3. All these figures are very very attractive. The company has low debt and you’re still looking at a company with a debt to equity ratio of 0.8. You know, for value, I usually look for this ratio to be under 1 so still everything favorable. So when you combine its fundamental valuation, its earnings multiple, its sales multiple, price to cash flow ratio and its positive earnings, low debt and trading well below its highs of years gone by, the stock automatically becomes a long candidate in my opinion especially if we look at the earnings forecast that the stock has in the next few years.

The long term 5-year earnings growth average is 11%. Now, as you’ve seen there on the chart above, the market is pricing in over 17% earnings declines in 2016. The question really is whether this has totally been priced into the stock at this stage. Analysts are projecting that earnings will return to positive growth from the first quarter on in 2017. Now, I’m a firm proponent that stocks usually bottom well before earnings return to positive growth.

Why? Because the market is always projecting at least 6 to 12 months out, so all we need to see is the company basically doing what it is projected to do regrading earnings growth. And remember, this company ties in with what I discussed already on oil in the sense that I’m long term bullish on oil. So this company, Regal, has suffered a lot like a lot of industrials, especially companies like General Electric (NYSE:GE) from their oil and gas revenues over the past few years. You know, a rise in the oil price is definitely going to help this company. So, I would be looking to get long here. Earnings next week could actually form a hard bottom in this stock. But this stock is for the investor who is a long term value holder.

Market timing is one of the most difficult skills a trader or investor can learn, and nobody knows where the stock market will be next month or three months from now. So, to trade this type of market, if you’re going to trade it getting long stocks, you need to be really getting into stocks that are offering very good fundamentals, and that are very cheap compared to their historic averages.

If we go down now to the next chart which is of Gilead, ticker symbol (NYSE:GILD), this stock announces earnings tomorrow. I have been following this stock for quite a while now, actually watching it drop consistently over the past while. And you know, sentiment has become very bearish on this stock, I think unfounded to a very large degree. Yes, its HCV sales have been dropping a lot over the past two years now but I believe the bearishness is unfounded because if you look at the biotech sector in general, the whole complex has been dropping. But Gilead because it’s a large cap and because of its earnings and margins gets special attention when it drops as much as it has. The company is announcing earnings tomorrow and I am bullish on this stock despite not knowing when we’re going to get the final bottom in the biotech complex. But again its valuation looks extremely attractive, 6.5 earnings multiple compared to a 21 5-year average, 3.3 sales multiple compared to a seven 5-year average, Price to cash flow 5.9 which is well under the 10 I look for. Very very healthy, profit margins also.

Something that I think bearish analysts are missing on the HCV side is although sales are dropping, this division is still a huge cash cow for the company in the sense that it generates huge margins & huge cash flows. And I don’t think the growth here is finished like a lot of bearish analysts believe it has. The company will have its 1st Quarter now of Epclusa which is a new Hepatitis C drug which is cheaper than the likes of Harvoni and Sovaldi and can be used on more genotypes so this drug is very exciting. Plus Gilead has more drugs in Phase 1 to Phase 3 trials in this division that will enhance its superiority in this sector. There is not a doubt in my mind that we are going to get a bottom in this division for Gilead. The only question is when. Its trailing 12-month average growth margins are 87% which is extremely impressive. Its earnings per share last year got to 11.91 but we’re still at 11.34 on a trailing 12-month average basis this year so we’re not that far behind. Debt to equity ratio is at 1.38 which is very good for the biotech sector where you see an awful lot of M&A activity.

So, my trade for earnings for Gilead would be something like a put or selling a put spread that expires this week. If one gets put the stock at $70., I would be encouraging you to take hold of that stock because this stock at $70 is a cheap stock. So, that would be my trade setup for Gilead. It has plenty of premium in its options. Implied volatility is very high so one could sell a naked put at the $70, $71 level or even a $4 or $5 wide put spread. But again be careful. Think with the end in mind. Do not put on this trade if you do not have the capital to take hold of the stock.

 

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