Wednesday, December 11, 2013

CAH: A problematical chart

Cardinal Health Inc. (CAH) is in the final stages of a rise that began Sept. 20, 2012 from from $36.91. That uptrend is in turn part of a very long term retracement within a downward correction that began in April 2007 from $76.16.

CAH on Tuesday broke above its 20-day7 price channel, at $67.75.

The $76.16 level is important. In Elliott wave terms, that marks the start of the A wave in the correction. The B wave, under Elliott doctrine, never rises above the start of the A wave.

So if my count is correct, then CAH has at the maximum 16.4% of upside potential beyond the breakout level before running afoul of the rules.

Click on chart to enlarge
CAH 2 years daily bars (left), 90 days 2-hour bars (right)

Rules are made to be broken, except in Elliott wave counting. A broken rule in Elliott means that count is wrong and must be redone.

There is, of course, no certainty that the price will approach any closer to that level. The downturn that  began from $67.75 a bit  before 1 p.m. New York time on Tuesday may mark the end of wave 5 and indeed of wave B {+4}.

Or not. Price movements on Wednesday and Thursday will clarify whether or not the rise from 2009 is indeed over.

I count wave 5, the final wave of the present uptrend, as having begun Sept. 6 from $49.65, and the lower degree wave 5 {-1}, from $62.55 on Dec. 5.

However, there are problems with the count, and I can't resolve them with the information presently available. Explaining the issues will require a hike through the Elliott wave weeds.

The magnitude of the preceding wave 4 {-1} seems a bit shallow given the stretch of wave 3 {-1}, which gives me a slight pause. However, there's nothing in Elliott that requires a deeper dip.

The trend channel at the {-1} degree (in black) is quite malformed, showing wave 3 {-1} leaping past the upper boundary.

A revised trend channel (in red) that treats wave 3 {-1} as wave 1 {-1} solves the trend channel problem,  but the pesky shallow correction that follows remains a puzzle.

Also, the revision makes wave 1 {-1} $15.80 long. Under the rules, a 3rd wave cannot be shorter than both the 1st and 5th waves in the series. The revised wave 3 {-1} from Dec. 5 would have to exceed $78.35, which breaks higher than the prior wave A {+4} that began the correction in 2007.

There are no easy answers on this chart. Every possibility ends in impossibility.

Another possible solution is to consider my count to be incorrect in labeling of the decline beginning in April 2007. If the correction ended in 2009, then my wave B {+4} becomes wave 1 {+4}, the start of a new uptrend. Under that count, $76.16 is no longer a barrier but a price level that must be breached.

With all things Elliott, as in the X-Files, the truth is out there and will be revealed in the fullness of time. In the meantime, I shall stand by my original count (using the black trend channel). It is inelegant, but it breaks no rules.

Near term or longer term, CAH has shown impressive momentum. This is the seventh bull signal since wave 5 {+2} began on Sept. 20, 2012. Of the six completed signals, four were successful for an average yield of 7.6% over 36 days. The two unsuccessful signals lost 1% over 31 days, giving a 6.6% win/lose yield spread.

Nearer term, there has been one prior bull signal in wave 5, which began Sept. 6. It yielded 19.5% over 58 days, mainly as a result of the high energy wave 3 {-1} rise.

Cardinal Health, headquartered in Dublin, Ohio, provides the everyday things the medical industry needs to operate: surgical clippers, skin adhesives, facial protection, headwear and footwear, drapes and gowns.

One possible narrative for the company is that the health-care reforms will bring more people into the medical system. Another is aging members of the Baby Boomer generation are entering their peak years for healthcare consumption. Both mean increasing demand for Cardinal's products.

Analysts in the aggregate are positive about Cardinal's prospects, giving it a 38% enthusiasm index.

The company reports 22% return on equity, but with debt a bit higher than I like to see at 59% of equity.

Earnings tend to peak in the first quarter of the calendar year, and those earnings have come in higher than the year-ago quarter for at least the past three years.

Cardinal's earnings have surprised to the upside in every quarter on my three-year chart.

The earnings yield is 1.74%, less than that of 83% of other companies in the biotech and drugs sector. The quarterly dividend works out 1.82% a year at today's prices, meaning that at present, Cardinal is paying out more to shareholders than it earns. Retained earnings work out to a negative 4.67%.

The stock is priced at 57 times earnings but is selling at a steep discount to sales. It takes only 22 cents in shares to control a dollar in sales.

Institutions own 86% of shares.

CAH on average trades 3.4 million shares a day and supports a wide selection of option strike prices spaced $2.50 apart near the money, with open interest running to three and four figures. The front-month bid/ask spread on calls is a bit wide, at 13.3%.

Implied volatility stands at 22% and has declined from its one-month peak attained on Tuesday. Volatility is at the 91st percentile of the one-month range, a high level that implies trades structured as short bull plays, such as bull put spreads, will have the best chance of success.

Options are pricing in confidence that 68.2% of trades will fall between $62.16 and $70.80 over the next month, for a potential gain or loss of 6.5%, and between $64.41 and $68.56 over the next week.

Contracts trading today are skewed toward calls, which are running 37% above their five-day average volume. Puts are at 84% of their average.

Cardinal next publishes earnings on Feb. 3. The stock goes ex-dividend Dec. 3 for a quarterly payout of 30.25 cents.

Decision for my account: The ambiguities on this chart bother me a lot. The revised counts I discussed above make a decent bullish case, but I don't find them convincing. My chart analysis leaves me convinced that CAH is nearing the end of its rise.

The wave B {+3} correction  could well decline by 38% (to $42) or more. I'd rather avoid that and instead catch the C {+3} rise that will follow. This is long-term stuff, but the truth is, I don't like B waves. I find them to be hard to play at any degree.

Also, I'm one with Warren Buffett when it comes to dividends. I'd rather the company held on to the money and increased its value so I can pocket capital gains. The negative retention of earnings cuts against my grain.

And finally, if Cardinal's prospects are so good, why is the stock priced at such a low fraction of sales per share?

So I'm passing on CAH, mainly because of the chart and also out of distaste for the dividend and suspicion of the price in relation to sales.


My shorter-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 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.

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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