Tim Bovee, Private Trader: TRN: Infrastructure for industry

Trinity Industries Inc. (TRN) is embedded in the old-line business of making things from raw materials and moving around the country on rails and water. It seems like a throwback, a nostalgia play harking back to the days when big industry was the economy.

Yet this old-line company has a chart that would do Silicon Valley proud, and proved its bullish chops again on Friday when the price broke above the 20-day price channel to yet another all-time high.

The Chart

Elliott wave analysis places TRN in the sweet spot -- a series of middle waves of ascending magnitude that promises upside potential, albeit with the usual corrections.

Nearer term, TRN is in the final wave to the upside of wave 3 {+1}, which began June 24, 2013 and which has nearly tripled the price.

Click on chart to enlarge.

TRN 20 years monthly bars (left), 2 years 7 months daily bars (right)

Within wave 3 {+1}, the 3rd wave one degree smaller came in longer than the 1st wave, which means there are no limits in Elliott on how far the 5th wave can go. It has already traveled farther than the 3rd wave -- $33.42 vs. $24.38 -- and has lasted longer -- 11 months vs. 10 months.

Proportionality, however, while aesthetically pleasing and often seen, is not a requirement in Elliott wave theory. The 5th wave is bouncing along the upper boundary of the wave 3 {+1} trend channel, which suggests its run is nearing an end. On the other hand, it has been at the boundary since May, so "near" can mean several a longer period of time than it does in common speech.

The 2nd wave correction in 2013 was a Zig-Zag. When the 4th wave correction does come, the rule of alternation suggests that it will be a Flat, what chartists in retrospect will call a sideways correction.

The two most prominent Fibonacci retracement levels, if the correction were to begin today, would range from $36.99 down to $29.47, or 38.2% to 61.8%.

TRN poses the perennial question faced by traders, not "how high" but rather "when". The chart provides no answer.

Odds and Yields

The historical odds show the energy of wave 3 {+1}. TRN has completed five bull signals in that time. All were successful, on average yielding 7.5% over 30 days. In other words, no whipsaws.

At a lower degree, wave 5 produced one of those bull signals. It yielded 6.9% over 28 days.

The Company

Trinity Industries, headquartered in Dallas, Texas, began as a steel company but has since diversified. It provides some of the infrastructure of industry with a focus on moving things. It makes, sells, leases rail cars and provides management services for them. It manufacturers barges used on inland waterways.

It provides a range of products and services used in transportation, construction and energy.

The advantage of a company like Trinity is diversification across sectors. A manufacturer is limited to its mix of products. An infrastructure and services company like Trinity can serve many manufacturers across many product lines.

Analysts are optimistic about Trinity's future prospects, in aggregate coming down with a 43% enthusiasm rating.

The company reports return on equity of 21%, high enough to put it into growth-stock territory were it not for the high level of debt, which is about equal to equity.

Earnings had been on the rise from the 4th quarter of 2012, but then declined in the most recent quarter. All 12 quarters over the past three years have produced positive earnings surprises.

The earnings yield is 7.74%, compared to a 2.39% yield on the 10-year U.S. Treasury notes. The company pays a dividend yielding 0.82% annualized at today's prices.

Earnings and growth estimates along with the dividend imply a "fair" price of $44.74 per share, meaning that TRN is overpriced by 9.1%. That's quite a small premium compared to many other companies I've analyzed. I've marked the "fair" price on the left-hand chart in purple.

The stock is selling for 13 times earnings, and also at a premium to sales. It takes $1.42 in shares to control a dollar in sales.

Institutions own 80% of shares.

Trinity Industries next publishes earnings on Oct. 28. The stock goes ex-dividend in October for a quarterly payout of 10 cents per share.

Liquidity and Volatility

TRN on average trades 2.6 million shares a day and supports a moderate selection of option strike prices spaced $5 apart, with open interesting running to three and four figures near the money.

The front-month at-the-money bid-ask spread on calls is 7.7%, compared to a 1% spread on the most-traded symbol in the U.S. markets, the exchange-traded fund SPY.

Implied volatility stands at 35% and has been declining since late June, when a sudden spike pushed volatility above 100%. By contrast, volatility on the S&P 500 index is 12%.

After tossing out the spike as an outlier, TRN's volatility stands at the 58th percentile of its one-year range. Technically, that means that long shares or an equivalent built from options have the best chance of success. It is close enough to upper two quintiles that options spreads sold for a credit might also do.

The spike is troubling when it comes to assessing options. So my inclination will be to go with shares on any position I open.

Options are pricing in confidence that 68.2% of trades will fall between $43.72 and $53.46 over the next month for a potential gain or loss of 10%, and between $46.25 and $50.93 over the next week. I've marked the monthly range on the right-hand chart in blue.

Contracts today are trading below their five-day average volume, with a slight skew toward calls, at 9% below average, compared to puts, at 18% below average.

Decision for My Account

TRN has a bullish chart and good fundamentals. I see two areas of concern:

The present wave 5 will be followed by a significant correction.
My nervousness over the options spike means I can't take advantage of the leverage and hedging capabilities that options provide.

In practice, I worry little about 5th waves. I've seen them go on for an extraordinary length of time, and I've seen very smart traders miss out on significant profits because they refused to take the risk.

The lack leverage and hedging, however, tells me that I can use my money more productively. Moreover, I have a heavy commitment to share trades at this point and am reluctant to add another.

I'm bullish on the stock, but the options spike has punctured any potential trade on my account. I won't be opening a bull position in TRN.

-- Tim Bovee, Portland, Oregon, Aug. 25, 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.

From time to time 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.