Playing a Great Company on a Pullback
By Paul Price of Market Shadows
Originally published on Jan. 8, 2014 on TalkMarkets.com TalkMarkets
Many peoples’ fantasies revolve around getting top quality products at bargain prices. That is especially true for Costco’s members.
Shares don’t get much higher in quality than Costco (COST).
Unlike their merchandise, Costco is rarely available at discounted valuations. The stock raced as high as $126.12, or about 26 times forward earnings recently, on FY 2014 (ends Aug. 31, 2014) estimates of $4.86 per share.
Standard & Poors noted that Costco hasn’t sold for less than 20 times earnings since 2010. COST peaked at multiples of 25x or above during each year since 2006. Value Line says Costco’s 10-year median P/E is 22x.
Well-respected research firm Morningstar calls present day ‘fair value’ as $115. That is pretty close to Wednesday’s closing quote of $114.05.
Option savvy traders might want to take advantage of the pullback from $126 to sell long-term puts. The technique allows for two full years of expected profit and dividend growth to burnish Costco’s value.
Writing puts also provides a nice margin of safety by establishing ‘if exercised’ prices that are well under the present quote.
I sold January 2016, expiration puts at $95, $100 and $105 strikes today. Here’s the very simple math on those options at their last actual trade prices.
Break-evens on the more conservative $95 and $100 strikes would get you into the stock at net costs dollars lower than any shares changed hands for in all of 2013. The worst case scenario on the more optimistic $105 put would take you back to a share price last seen eight months ago.
Selling puts mitigates the fear of seeing COST go even lower in the near future. You will either buy at a deeper discount or get paid not to buy.
That’s something Costco shoppers should appreciate.
