Tuesday, July 10, 2012

TGT: A big box with style

With earnings season having kicked off yesterday, stock picking becomes a bit more difficult. One of my trading rules is not to open a new position on a stock within a month of an earnings announcement. Stocks respond to expectations well before the announcement, and it doesn't pay to get in too late.

There's the added problem, for options traders like me, of ensuring the trade will expire before the next earnings date. That narrows the field considerably.

And in fact, out of stocks selling for $15 or more and trading 2 million shares and above three hours after the market open, I found only 15 stocks that didn't have an earnings announcement between now and my final close date for August options.

Of those, my top pick is the big box retailer Target Corp. (TGT). The Minneapolis, Minnesota company is the second-largest discount retailer, after Wal-Mart. It runs 1,767 stores in the United States, and is expanding into Canada.

The remaining top choices out of the 15 stocks are Wal-Mart (WMT), Gap Inc. (GPS) and Home Depot (HD) -- all retailers. I'll look at those stocks during the remainder of the week.

I selected TGT not because its chart had the most momentum -- that honor goes to WMT -- but because it has just broken free of a sideways trend. Whether that breakout will persist remains to be seen -- there are no certainties on the charts -- but the price positioning gives TGT the potential for a renewed uptrend.

TGT this year rose from $49.02 in January up to $58.95 on March 16. Since then the stock has traded between roughly $55 and $59, with the occasional break beyond those bounds.

It broke to the upside up to $59.40 on June 11 and immediately dropped back, reaching below $57.

Today it broke out to a high (so far) of $59.47.

So the chart is showing a buy signal in terms of breakout analysis. I play those situations by buying on the breakout but keeping a close stop/loss in place. Certainly a close below the breakout level ($59 in this case) destroys the chart's rationale of the trade.

Target's plan is to differentiate itself from the other big-boxers by selling products with striking designs. There attitude is that a big-box price need not mean the sacrifice of style.

Target reports return on equity of 19%, with long-term debt amounting to 94% of equity, a fairly high level.

Annual earnings have risen steadily since the recession nadir in January 2009 (the company's fiscal year ends Jan. 31).  The all-important 4th quarter Christmas season earnings have also risen steadily.

Of the last 11 quarters, nine have shown earnings surprises to the upside, and two to the downside.

Institutions own 82% of shares, yet the price is cheap; it takes only 54 cents in shares to control a dollar in sales.

The 19 analysts following TGT show an enthusiasm index of 21%, unchanged from a month ago.  (My enthusiasm index gives positive weight to strong buy recommendations, ignores buys, and gives negative weight to holds, sells and strong sells.)

TGT on average trades 5.1 million shares a day, sufficient to support a moderate selection of option strike prices with high open interest and narrow bid/ask spreads.

Options are trading well above the 5-day moving average, with calls outpacing puts 3:1.

Implied volatility stands at 22%, about the midway point of the six-month range. Options are pricing in confidence that 68.2% of trades will fall between $55.71 and $63.11.

Today's breakout sent the price up to $1.25 above the fair price range, which runs from $57.26 to $58.22. The range contains 68.2% of trades surrounding the most traded price, $58.02.

Target next publishes earnings on before the open on Aug. 13. The August options expire on Aug. 20, although I normally close my positions the Monday before expiration, which would be Aug. 12 in this case, the day before earnings.

The stock goes ex-dividend on Aug. 13 for a quarterly payout yielding 2.42% annualized.

Decision for my account: I opened a bullish position on TGT today. I structured it as a bull put spread expiring in August, short the $57.50 strike and long the $55 strike. This trade provides a net credit.

The position has a risk/reward ratio of 4:1, which is a potential profit of 26%.

The position is profitable down to around $57, so I wouldn't close it unless the price fell to that level. This gives plenty of cushion to allow for some retracement below the breakout level.

I screened the 15 stocks meeting my criteria using a tourney bracket with a one-month daily chart and a three-day half-hour chart, and then turned to a five-year weekly chart for the broad context in analyzing the bracket winner. See my essay "10,000 Charts" for a discussion of my screening methods.
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 decision decisions for his or her own account, and take responsibility for the consequences.

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