Tim Bovee, Private Trader: ILMN: Is the party over?

Illumina Inc. (ILMN) went public in 2000, a few months after the great market upswing from 1974 at long last came to an end. Look at a 20-year chart, and you'll see that the markets have indulged in a lot of drama but have basically gone hardly anywhere since then.

Yet during the storm and fury and churn of the ensuing years, as the S&P 500 underwent great swings that reached their lowest point in early 2009, the depths of the Great Recession, ILMN has chugged merrily along, fluctuating as all stocks do but avoiding the extremes of the Blue Chips.

Because of that independent course, I've chosen to analyze ILMN on its own terms, rather than trying to frame it within the advances and retreats of the general market.

ILMN did indeed come to the party late, but rather than mingling with the other guests when they get falling-down drunk and surly, it seems determined to party cheerfully on its own.

In recent months, however, ILMN has lost some momentum; its walk has become a bit unsteady as it tries to find its way back to the punch bowl. ILMN's chart poses a simple question: Is the party over?

The Chart

Elliott wave analysis suggests that ILMN, in breaking past its 20-day price channel on Thursday, is working through a B-wave to the upside amid a correction of the decline from $18.3.30 that began March 4.

It was a bull signal, to be sure, but within a bearish context, and probably not a trend to be safely played at this point.

For bulls, the good news is that the correction is happening within a 4th wave, and so the next step when it is done will be a renewed rise that will exceed the March 4 high as wave 5 {+1}.

Click on chart to enlarge.

ILMN 14 years weekly bars (left), 90 days hourly bars (right)

The decline is atypically formed, with an exceptionally long 1st wave and a 5th wave that ends before reaching the terminus of the 3rd wave. (See the yellow circle on the right-hand chart.) This is called a "truncated" 5th, and I've not seen it often.

Despite those anomalies, the 3rd wave is longer than both the 1st and the 5th at the {-1} degree, and therefore the A wave meets the requirements of the Elliott rule set.

The A wave has taken about two months to complete, and if the B wave is proportional, it could last into late June before turning down as a powerful C wave.

Elliott has no strict guidelines regarding time, however, and there is nothing in the rules that would prevent ILMN from reversing next week.

When wave 5 {+1} is complete, ILMN will go through a 2nd wave correction and then resume its rise as wave 3 {+2}. That in turn is the middle wave of the rise from October 2011, wave 3 {+3}.

If I count entirely in terms of the ILMN chart, then wave 3 {+3} is the middle wave of 1 {+4}, which means that ILMN has much upside ahead of it. However, it could just as easily be a 3rd or a 5th wave.

Options are pricing in confidence that 68.2% of trades will fall between $143.36 and $177 over the next month, for a potential gain or loss of 10.5%, and between $152.10 and $168.26 over the next week.

I've shown those price levels on the right-hand chart in blue.

Odds and Yields

ILMN has completed 10 bull signals since wave 3 {+3} began in 2011. Six were successful, on average yielding 27.2% over 44 days. The four unsuccessful signals lost 5.4% over 20 days, on average.

The record shows that ILMN has been more prone to winners than to whipsaws during its most recent rise, and the resulting 21.8% win/lose yield spread is quite enough to overcome the occasional losing trade.

The present bull signal is the first since the present decline began in March.

The Company

Illumina, headquartered in San Diego, California, develops, makes and sells technologies used in analyzing genes. This puts it on the cutting edge of medical research.

The cutting edge is an exciting place with a great view of the future. But it is also a risky place, where a wrong step can send a company tumbling over the edge into oblivion.

Analysts are mildly bullish about Illumina's prospects, collectively coming down with a 6% enthusiasm rating.

The company report return on equity of 18% with debt amounting to only 9% of equity. If ROE were 20% or better, then I would consider ILMN to be a growth stock.

Illumina's earnings yield is 0.9%, compared to the 2.53% yield on the 10-year U.S. Treasury note. The company pays no dividend.

Earnings growth implies a fair price of $43.34, which is a bit more than a quarter of market price. That's a huge premium based on hope and would concern me for a trade under my longer-term rules. ILMN, however, is a candidate under my shorter-term rules, where such price-to-growth is less important.

I've marked the "fair" price implied by growth on the left-hand chart in purple.

The stock is selling for 111 times earnings, and also at a premium to sales. It takes $12.93 in shares to control a dollar in sales.

Quarterly earnings have risen steadily from the beginning of 2012 onward. There has been only one downside earnings surprise in the past three years, and that was in the 3rd quarter of 2011. The other quarters all surprised to the upside.

Institutions own 109% of shares.

Illumina next publishes earnings on July 21.

Liquidity and Volatility

ILMN on average trades 1.3 million shares per day and supports a wide selection of option strike prices spaced $5 apart. The front-month at-the-money bid/ask spread on calls is 6.7%, compared to 0.5% for the most-traded symbol on the U.S. markets, the exchange-traded fund SPY.

Implied volatility stands at 36%, compared to 12% for the S&P 500 index, and has been declining from 66% beginning April 21. ILMN's volatility is at the 20th percentile, suggesting that the best success will come from a position structured as long option spreads bought with a debit and expiring in September.

Options are trading quite actively today with a bias toward calls, which running at 148% above their five-day average volume, compared to 125% above average for puts.

Decision for My Account

I like ILMN as a company but I don't like its chart at this point. The B-wave correction will reverse within a month or so, to be followed by a deep C-wave dive. I would very much like to avoid that.

I won't open a bull position in ILMN but will wait for the end of the C wave and the beginning of wave 5 {+1} to the upside.

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.