Tim Bovee, Private Trader: CTL: Santa's bear

Update 7/11/2014: CTL never showed sufficient downward momentum for me to open a bear position and on July 10 closed above its 10-day price channel. I've removed the symbol from my Watchlist.

Stocks with high dividends are like Santa Claus or a doting grandparent. They keep handing out little gifts every so often, without the need to agonize over momentum, trends and all the other measures of worthiness.

Century Link Inc. (CTL) has a high dividend and fundamentals that are far from awful. It's a Santa Claus play by any measure. But then there's the chart, which reveals that Santa has replaced his eight happy reindeer with a big, bad bear.

The Chart

Elliott wave analysis shows CTL tracing a combination correction, a very large-scale structure that has been underway for 15 years.

Corrections in Elliott can be zig-zags, with marked movement to the downside. Or flats, which are sideways corrections. Or various sorts of triangles.

A combination stitches together several of those simpler patterns, producing what is called an "X wave" an boundary marker.

Click on chart to enlage.

CTL 20 years monthly bars (left), 3 years 7 months 2-day bars (right)

The first portion of the combination was a flat, from 1999 to 2008. The X wave began in 2008 and ended in December 2010. From that end point, the next portion of the combination began.

The major task of analysis in this chart is identifying what sort of pattern the second portion is. And that, in turn, requires a digression into the complex subject of Elliott wave corrections.

Corrections generally -- not always -- come in three waves: A with five subwaves, B with three subwaves and C with five subwaves.

However, in some variations the A and C waves will have three subwaves rather than five. And sometimes, the correction pattern will be composed of five waves rather than three.

Inelegant? Yes! It reminds me of an observation I've read about families: Normal families all have the same set of virtues that make them functional, while disfunctional families are all broken in unique ways.

Perhaps in the world of the markets the primary trend, with its invariable five-wave pattern with subwaves structured 5-3-5-3-5, are the functional times, filled with confidence and joy, and corrections are studies in disfunction, times of panic and distrust.

Whatever the reason, as a lawyer I had hired once said, it is what it is. As private traders, we deal with reality and don't worry much about causes.

The decline from December 2010 frames nicely as three waves down, with a fourth wave possibly having peaked on May 16 at $38.21.

That interpretation suggests that the second portion of the combination will work out as a 5-3-5 pattern of subwaves, which in turn suggests a zig-zag, with the final wave of the A {+3} wave having begun on May 16.

Under the Elliott rules, it will end somewhere below $27.83, the terminus of wave 3 {+2}, and thereafter will be followed by a B {+3} retracement to the upside. The waves of the {+2} degree have taken a year or so to complete, so by that analysis, CTL has quite a bit of downside potential remaining.

My counterpoint argument is that May 16 may not mark the end of wave 4 {+2}. Under the Elliott rules, wave 4 {+2} can go as high as $43.43, the terminus of wave 2 {+2}.

Options are pricing in confidence that 68.2% of trades will fall between $34.75 and $38.03 over the next month, for a potential gain or loss of 4.5%, and between $35.60 and $37.18 over the next week. I've marked the month range on the right-hand chart in blue.

Odds and Yields

The historical odds of a successful bear trade are a weakness in the CTL analysis. The stock has been prone to whipsaws since the present decline began in 2010 as wave A {+3}. In the shorter term, since wave 3 {+2} began in 2012, it has avoided whipsaws but has punished unsuccessful trades more severely than it has rewarded successful ones.

By the numbers:

CTL has completed 15 bear signals since the decline from 2010 began. Eight were successful, on average yielding 2.5% over 24 days. Seven were unsuccessful, losing 3.9% on average over 14 days. The resulting win/lose yield spread is a negative 1.8%.

Six of those signals were within the decline that began in 2012. Five were successful, on average yielding 2% over 25 days. One was unsuccessful, losing 9.2% over 12 days. The win/lose yield spread is huge, a negative 7.2%.

While historical odds are backward looking by definition, I've found that stocks tend to stay true to their historical natures. The CTL odds are less than promising.

The Company

CenturyLink, headquartered in Monroe, Louisiana, is a telecommunications company, providing landline and long-distance telephone service and Internet services.

Analysts collectively come down with a negative 13% enthusiasm rating for CenturyLink. That level generally shows a lack of confidence but falls far short of fear and loathing. It's negative, but moderately so.

The company reports return on equity of 9%, also moderate, but with a high level of debt amounting to 20% above equity.

Earnings hit a three-year peak in the 1st quarter of 2013 and then fell for three quarters straight, recovering somewhat in the most recent quarter, the 1st of 2014. Earnings have surprised to the downside three times in the past three years, most recently in the 4th quarter of 2013.

The earnings yield is 7.31%, compared to a 2.61% yield on 10-year U.S. Treasury notes. The quarterly dividend yields 5.94% annualized at current prices.

The dividend amounts to 81% of earnings, meaning that ownership of the stock is largely driven by earnings. That, I think, increases the likelihood that longer-term investors will hang on to the shares in bad times as well as good, in order to benefit from the quarterly dividend payment. That, in turn, would provide some cushion against declines, I would think.

Earnings growth estimates, when the dividend is taken into account, imply a "fair" price of $15.23. By that measure, the stock is overpriced by 139%. I've marked the growth-implied price on the left-hand chart in purple.

The stock is selling for 14 times earnings but at a slight premium to sales. It takes $1.15 in shares to control a dollar in sales.

Institutions own 72% of shares.

CenturyLink next publishes earnings on Aug. 4. The stock goes ex-dividend in September for a quarterly payout of 54 cents per shares.

Liquidity and Volatility

CTL on average trades 3.8 million shares a day and supports a wide selection of option strike prices spaced a dollar apart, with open interest running to four figures near the money.

The front-month at-the-money bid/ask spread on puts is 10%, compared to 1.92% over the most-traded symbol on the U.S. markets, the exchange-traded fund SPY. I generally prefer single digits for the percent of spread, but this is close enough to my criteria that I can work with it.

Implied volatility stands at 16%, the low point of the past year. By contrast, volatility on the S&P{ 500 index is 13%.

The low level of volatility on CTL implies that trades structured as long option spreads bought with a debit will have the best chance of success.

Decision for My Account

It's a bearish chart of an overpriced stock with fundamentals that are somewhat unimpressive. The one troubling aspect of CTL are the historical odds, the stock's tendency to whipsaw.

I'm impressed enough with the bearish chart to be willing to take on that whipsaw risk, to defy the odds, so to speak. My trading rules, after all, have a lot of protections built in to guard against whipsaws: The relative close and rigidly adhered to stop/loss system, the need for confirmation before making a trade.

I intend to open a bear position in CTL on Friday if it shows downward momentum in the half hour before the closing bell. If momentum falters, then I'll place it on the Watchlist.

-- Tim Bovee, Portland, Oregon, June 12, 2014

References

My shorter-term trading rules can be read here. My longer-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

By preference I place my shorter-term trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.