Tim Bovee, Private Trader: TMUS: Not all disrupters are moneymakers

Update 8/7/2014: TMUS closed below its 20-day price channel, producting a bear signal just a few days after a bull signal, which is definitely a candidate for the Whipsaw Hall of Fame.

The bear signal will require confirmation on Aug. 8 before TMUS becomes a potential bear play.

Update 8/6/2014: My caution about TMUS proved to be well founded. It failed to confirm its bull signal in spectacular fashion with a downside opening gap to the downside of 8.9%. The drop came on news that Sprint had dropped its attempt to buy T-Mobile. The Bloomberg News report by Alex Sherman, Cornelius Rahn and Olga Kharif may be read here.

The decline brought TMUS below its 20-day price channel, but it closed above the boundary, avoiding a bear signal, for now at least. A close below the channel confirmed the next trading day will under my rules require that TMUS be removed from the Watchlist.

T-Mobile US Inc. (TMUS) has fallen from its high in May and then returned to the upside with a great deal of power. The rise powered TMUS through the upper boundary of its 20-day price channel on Tuesday. The bull signal will require confirmation on Wednesday in the form of TMUS trading above the $33.88 breakout level if it is to be considered valid.

The company has a reputation for innovation, as a disruptive managment bent on changing a wireless telcom industry grown complacent and set in its ways. But just as not all upswings are bull trends, not all disuptive innovators are moneymakers.

The Chart

The key questions I'm asking of the TMUS chart is the nature of the decline from the peak of $35.50 on May 29 and the nature of the sudden rise that followed.

Elliott wave analysis shows that TMUS completed the third wave of its rise since it began trading on May 1, 2013.

The ensuing decline has come in three waves, one to the downside, a largely sideways correction, and then a further move to the downside. I've counted the waves as an A-B-C pattern that completes the correction, although it might well be only the first step in a longer-lasting correction.

Click on chart to enlarge.

TMUS 2 years daily bars (left), 2-1/2 months hourly bars (right)

TMUS in its decline is correcting a portion of the rise from $22.95, which is wave 3 {+2} on my chart. The corrective wave is 4 {+2}, and when it is complete, TMUS can be expected to rise above the $35.50 peak.

Elliott wave analysis doesn't require corrections to be proportional in time or space of the wave being corrected, beyond the simple rule that the correction cannot move below the beginning of the wave. In this case, it means that the present decline cannot fall below $22.95. That aside, anything goes.

However, waves do seem to have a rough proportionality in their lifespans, sometimes at least.

The present declined is composed a waves at the {+1} degree. The comparable degrees within the wave being corrected, wave 3 {+2}, lasted an average of 47 days. The three waves of the correction after the May 29 peak lasted an average of 21 days.

That's a significant difference and strengthens the possibility that the correction is in its early stages. Perhaps the A-B-C pattern completes the zig-zag, but proportionality suggests is in fact one degree lower, tracing out the first three waves of wave A {+1}.

In either case, internally, the decline traces out to a series of three-wave patterns, suggesting that the pattern is part of a Flat, a sideways correction often seen in 4th wave positions.

The decline has carried the price down to the 38.2% Fibonacci retracement level, a shallow retracement but a common sort. The rise from that July 30 low is the heart of the matter.

Here are the options:

If the rise is,

1) The beginning of wave 5 {+2} to the upside, then TMUS will carry above $35.50, perhaps significantly so.

2) Wave B {+1} in a zig zag, then it will be followed by a swift C-wave decline.

3) An A-wave or B-wave in a Flat, then it will be followed by a period of sideways movement, perhaps contained by a channel from $31 to $35. The movement may well be extended.

There's no way to choose among these options. Only time will tell.

The prudent course for a bull trade is to wait for a break above $35.50, which stands about 5% above Tuesday's closing price. That would buttress the case for option 1, the 5th wave scenario, which is the only viable choice for a bull play.

Yet another ambiguity is whether the rise from the IPO can be counted as having completed its 3rd wave at the {+2} degree.

Any new stock lacks a history on the chart and so is open to many interpretations. TMUS is only a bit more than a year old, a mere toddler in stock-market terms.

One way to deal with such questions is to look for an analog.

The VZ chart, tracking the stock of a major competitor in mobile communications, traced three waves to the upside beginning from the 2009 Great Recession low, peaking in May 2013 and beginning to rise again in January 2014.

That suggests that the count I've used is plausible, although not certain.

Odds and Yields

TMUS has completed six bull signals since it began trading in May 2013. Two were successful, with an average yield of 11.5% over 29 days. The four unsuccessful signals on average lost 2.25 over 21 days.

Despite the low win rate, only 33%, the win/lose yield spread is highly favorable to the bull side, at 9.3%.

The Company

T-Mobile US, headquartered in Bellevue, Washington, is a subsidiary of T-Mobile International AG, which is in turn a subsidiary of Deutsche Telekom AG, the German communications giant. It provides mobile communications services in the United States and its Caribbean territories. It is the fourth-largest U.S. wireless telcom company based on the size of the customer base.

T-Mobile US appears in Fast Company's "Most Innovative Companies 2014". The T-Mobile article is here.

Fast Company's Max Chafkin wrote of T-Mobile, "The cell phone industry is ripe for reform, but who expected changes to come within its own ranks?" He then listed T-Mobile's innovations, both in substance and style, as he made a case that the company is the leader in profound changes that will shake up the moribund sector.

T-Mobile has come to epitomize the sort of management that disrupts businesses sectors.

Of course, being a disuptive leader is far from being a guarantee of profits and rising stock prices, especially over the shorter term. For that reason, I would primarily consider T-Mobile as a potential play under my longer-term rules.

Analysts in the aggregate lean toward the positive side in assessing TMUS's potential coming down at a 6% enthusiasm index.

The company reports a low return on equity of just 1% with debt amounting to 154% of equity. From a near term perspective, these are unimpressive numbers.

Earnings have been spotty for the period since the initial public offering, with two out of seven quarters showing losses, most recently in the 1st quarter of 2014. The most recent report, the 2nd quarter, showed a sharp rebound in earnings.

TMUS produced an earnings loss over the past 12 months of -0.68%. The company pays no dividend.

Estimates are that TMUS will profit in coming years, although not at a rate commensurate with the current price. The present estimates imply a "fair" price of $2.03. The stock is presently selling at nearly 17 times that level.

T-Mobile US next publishes earnings on Oct. 29.

Liquidity and Volatility

TMUS on average trades 6.5 million shares a day and supports a wide variety of option strike prices spaced $1 apart, with open interest running to three and four figures.

The front-month at-the money bid/ask spread on calls, at 62%, is extraordinarily wide for a stock that liquid. The spread on the most-traded symbol the U.S. markets, the exchange-traded fund SPY, is 0.5%.

Implied volatility stands at 32% and has been falling since July 15. By comparison, volatility on the S&P 500 index stands at 17%.

TMUS's volatility is in the 24th percentile of its one-year range, suggesting that the most successful trades will be structured as long option spreads, bought with a debit and expiring in an out-month.

Options are pricing in confidence that 68.2% of trades will fall between $30.82 and $37 over the next month, for a potential gain or loss of 9.1%, and between $32.42 and $35.40 over the next week.

The comparable range over the next year is $23.19 to $44.63, for a potential gain or loss of 31.6%.

I've marked the one-month range on the left-hand chart in blue.

Contracts were trading slowly in Tuesday's session, with calls running at 60% of their five-day average volume and puts at 42% of average.

Decision for My Account

Based on the chart, I'm not going to open a bull position in TMUS at this point. I'll place it on the Watchlist with an entry signal at the May high, $35.50. I'll consider opening a bull position if TMUS closes above that level and confirms the signal by trading above that level the next day.

Even with a strong upsurge, the fundamentals give me some pause, and I'll revisit them if the entry signal occurs.

-- Tim Bovee, Fukuoka, Japan, Aug. 5, 2014 New York time

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.