Wang’s Happy Trading

Submitted by OptionDragon

Earnings!

For this week, I focused on stocks that should move volatile after earnings and earnings announcements that are of interest. Cross currents still move within the market tide as the FOMC rate decision on Wednesday could keep speculation and pre earnings moves down to a minimum until after the event. Risk aversion seems to be the theme going into the FOMC and earnings. You don’t want to be caught on the wrong side when Mr. Market decides to move on either. Earnings have been very volatile so far. Diagonal spreads and straddles with short strangles with options have proved to be the best option strategy so far when directly playing these catalysts because option premiums are so high due to volatility and high time value. Trading after earnings has also proved profitable as volatility and volume has been present on most earnings catalysts after the fact although because of volatility, timing has been difficult. Speculating on price direction before the earnings announcement has been extremely difficult with the negative market sentiment and not very favorable risk/reward scenarios with high option premiums. In some cases trading the stock had better risk/reward opportunities versus trading the “expensive” options. As a matter of fact our options site will now include stock trade prices as well as option trade prices in order to give all traders a choice of vehicles!

Right now, good earnings and guidance that coincide with a market uptrend seem to get rewarded. Any missteps on earnings or guidance and your stock price gets taken to the woodshed. Company executives are preplexed when they surpass expectations on all metrics and their shares still get punished. What are they to do? I would say its not your fault, it is just the market dynamics right now and the economic market cycle playing out with a risk aversion kicker. Just keep on growing and focused on high performance and when things turn around you will be noticed and remembered. Also of key importance is the elimination of the short tick rule which has fundamentally altered the mechanics of market liquidity IMO (giving short sellers more leeway and strength) and thus changing the rules of the game. Expectations on the more popular names seem largely priced in to the stock as the bears sit and wait to fade the gap after earnings on no new surprises. On our website, I have written an article about gap trading that could help one decipher some patterns. In the chat room we will discuss trade ideas, option and trade strategies and of course Happy will now relay trades in stock prices as well as options for those who only like to trade stocks.

The GOOG Machine
Even though GOOG’s earnings is probably the most watched event this week, it will be overshadowed by the FOMC policy decision. After the initial knee jerk market reactions, people should start focusing on the earnings calender more. GOOG’s share price will be influenced by the Fed action, AMZN and YHOO earnings, and market sentiment throughout the week.

GOOG is expected to bring in $4.44 a share with a $4.78 high estimate. GOOG revenues are expected to come in at $3.44 billion with a $3.60 billion high estimate. In the current quarter, GOOG’s growth estimate YoY is just under 40% versus the 11% for the sector. Going into earnings, analysts are split over how GOOG performed last quarter. GOOG does not give guidance so analysts will extrapolate off of current earnings in order to change their estimates and models.

These are the recent thoughts from analysts:
On a Jan 25th note, Jefferies said they expect strong results to be driven by seasonally strong ad spending, continued gains in search market share, and monetization improvements. They estimate revenue of $3.44B and EPS of $4.48. They reiterate a Buy with a $725 target.

On a Jan 25th note, Oppenheimer said they expect upside in Q4 from International and Quality Scoring and finds the risk/reward very compelling at current levels. GOOG remains their #1 stock idea with an $850 target. They keep GOOG at Outperform and say concerns about Q4 are overblown.

On a Jan 24th note, Stanford downgraded GOOG shares citing slowing e-commerce and search volume growth, along with the global slowdown. Lowering their recommendation from buy to hold while not presenting any new earnings forecasts or numbers.

On a Jan 24th note, William Blair advises caution into GOOG’s results as their regression analysis suggests some risk to the quarter. GOOG remains one of their top long-term picks, they believe it is unlikely that Q4 results will exceed expectations as has been the norm in recent quarters.

On a Jan 23rd note, Bernstein said they expect very strong results. Bernstein believes the company will return to its normal operating margins of 33% and report EPS of $4.44, which is inline with expectations.

On a Jan 23rd note, UBS came out with a cautious comment on the quarter but also saw a long term opportunity in the shares on any further declines or at this current level. UBS sees little upside to their 14.7% QoQ revenue growth estimate but views the recent pullback along with long-term prospects as a positive.

On a Jan 22nd note, Cowen said paid search spending remained strong and continues to recommend GOOG, but sees the odds of an upside surprise as low given the current environment. Their checks did indicate that solid Q4 demand for online ads and e-commerce growth were there.

On a Jan 15th note, Soleil’s revised their current Q estimates to reflect their lower-than-projected growth in page views and viewer traffic in the month of December as well as higher expense growth. Soleil lowered their Q4 estimate from $4.72 to $4.40
per share and kept their hold rating.

Now let’s look at important recent business developments and key metrics:
On Jan 4th, a Google patent recently was made public describing a method for computers to read text in images and video. Sources suggest that video and images would be searchable by the text actually located within either the video or image. A positive development in search and for the company’s core strength.

On Jan 8th, Hitwise reported that GOOG got 65.98% of all U.S. Searches for December an increase from 65.1% in November.

On Jan 13th, ZDnet gave food for thought with an article saying that online advertising revenue to the big three, GOOG, YHOO and MSFT could be hurt by the CFC buyout by Bank of America. The consolidation will eliminate a big advertising spender to the Big Three and their lavish spending ways will now be cut back by its new parent. I always see CFC ads on CNBC and other channels of mass media so this will hurt the industry as a whole as it has been with so many mortgage companies going out of business.

On Jan 14th, the NY Times said GOOG has seen a surge in traffic from the iPhone. According to internal data provided to NYT from GOOG, traffic to Google from the devices surged and surpassed incoming traffic from any other type of mobile device on Christmas. I love my iPhone, and think it rates up there with one of the greatest technological devices or products ever made. This is very positive news fundamentally and now a very important pillar to GOOG’s wireless growth strategy.

On Jan 15th, Clearwire and GOOG announced a collaboration to deliver the company’s popular Google Apps to Clearwire customers. Clearwire will begin migrating its current customers to Gmail and Google Calendar in the first half of this year. In addition, Clearwire customers will also have access to Google Talk. This would be an incremental positive.

On Jan 17th, comScore said GOOG sites had 31.3% of video market share in November.

On Jan 18th, Breakingviews.com gave some activist shareholder ideas to Yahoo’s management about changing the company strategy and focus in order to cut costs and deliver unlocked value by outsourcing its search to GOOG. This I take with a grain of salt, but if it happened barring a MSFT buyout, this would be a big positive for GOOG and its traffic and revenues for sure.

On Jan 23rd, comScore noted that GOOG search share slightly dipped from 58.6% in November to 58.4% in December. GOOG’s Q4 US Paid Click growth was up 8% QoverQ versus Q3 of 11%, showing slower growth and is one reason for the recent cautious comments from analysts. This key metric could give insight into GOOG’s earnings announcement and justifiably warrant caution. This I don’t take a grain of salt with.

GOOG has shown its hand on a couple of growth initiatives which will be wildly popular IMO. On Jan 24th, GOOG announced that YouTube was set to expand mobile service to include videos and other features called “YouTube for Mobile”. GOOG also unveiled a Google Health login page with several new features that allow users to build online health profiles and download medical records from doctors and pharmacies. Additionally, users will be able to get personalized health guidance and share selected information with family. Big news for those who’ve had problems with health care services and those who want easy access to their personal information. Next up, a full copy of your DNA and analysis of it. This venture could save lives or drastically improve them with faster results.

On the China front GOOG has about 25.9% versus BIDU’s 60% Q4 market share for search engines. YHOO has a 9.6% share and could be a strategic asset on this front if YHOO decided to forgo their search endeavors and align themselves with GOOG.

These metrics are from a consulting company called Analsys International.

The key technical level to watch are GOOG’s 50 week MA at $551.64. This moving average has been a major uptrend support line for the past two years. A sustained breakdown and violation of this major trendline could technically end the uptrend.

The Incredible ISRG
ISRG reports after the bell on Thursday with GOOG, very fitting as both will be super volatile. I’ve known about the story for ISRG for a long time. Their da Vinci machines are out of a sci-fi novel and are truly one of man’s greatest examples of the progression of technology in the medical field IMO. The price of the machines are high, the services and parts to maintain it are expensive and recurring, there is no competition and the global demand, marketplace and patient population growing. What’s not to love? There are some fund managers and institutions who are saying that this is ISRG’s year (it has been for years now). If ISRG starts really penetrating the global marketplace steady sustainable long term growth will occur. If you don’t know the story of ISRG and feel your too late and the stock too high, do your due diligence and you will find out there is only so many million dollar machines they can sell but thats not the real story about the Incredible ISRG. The story is in the expensive maintenance and the high profit margin replaceable parts that will act as a revolving door into the Incredible ISRG coffer. The more machines you sell, the higher future exponential growth in revenues you should incur. BUT it is a win-win-win-win situation, ISRG wins because of adoption and recurring revenues, hospitals win and are made more profitable by using the machines in many ways(more surgeries, high patient turnover, more efficient surgeries and ease on doctors), patients win due to less recovery time, smaller incisions with less scarring, improved healing time, etc., and of course insurance companies who are made more profitable due to less complications and shorter recovery times meaning lower in-hospital patient costs and shorter stays.

ISRG is suppose to bring in $1.04 a share this quarter with $175.36 million in revenue. High estimates are at $1.08 a quarter and $179 million in revenues. They have beaten the heck out of earnings for the past four quarters. Current growth estimates for this quarter YoY is 67.7%. On Jan. 8th, Wachovia downgraded ISRG from Outperform to Market Perform saying they believed the shares were fully valued and notes that the company may guide 2008 below consensus. They believed the expectations were too lofty and that hospital capital spending might be at risk this year. If this comes to fruition and they do pull an AAPL, they will get a haircut. Machine sales is the key metric in this week’s report. On Jan. 4, Zack’s came out with an update on ISRG maintaining a Hold rating. They also issued this comment,

“Without direct competition, ISRG’s main challenges to growth are overcoming the capital investment challenges and gaining physician adoption for each procedure specialty. At its current price of $323.95 per share, ISRG is trading at roughly 68x our 2008 EPS estimate and at roughly a 1.7x P/E/G on 2008 EPS, which is at a significant premium to the average peer group multiple of roughly 33x 2008 EPS and at a premium to the group 1.5x P/E/G. A significant premium is warranted on a P/E basis given the company’s growth prospects relative to its peers and lack of direct competition. We believe at this stage the majority of these growth prospects are already reflected in the company’s stock price. If financial results fail to meet growth expectations, the stock price could be negatively impacted. We believe the stock is fairly valued at roughly 73x our 2008 EPS estimate, or at roughly a 1.8x P/E/G on 2008 EPS. Our price target remains at $345 based on roughly 73x FY08 EPS estimate.”

If they thought it was fairly valued at $325 I bet they like it here and on great earnings at $269! The P/E ratios show growth and possible justification in their growth EPS estimates. ISRG will be a big mover no doubt. It really wouldn’t surprise me to see it move 30 points or more after earnings up or down. The biggest reason for its volatility is due to the float size of the shares at 37 million. They could split the stock and that could cause a short squeeze with great numbers and guidance. On a side note, in the chat room I was asked about short squeezes and what I look for. I look for a catalyst (earnings or news) and also a small stock float (under 100 million roughly, the lower the better) with a high short interest (above 5%, the higher the better) and high short ratio (above 3, higher is better), these a really rough estimates and each case is different. It also depends on price/action volume (no volume, no squeeze). Depending on the market environment I might do an even weighted strangle after hopefully a successful pre earnings play if it materializes. Other high level traders in the chat room could do more complex option plays.

The Marvelous MA
Cue ABBA’s Mamma Mia…Mastercard has been a darling for investors and has held up fairly well during the recent market downturn. MA reports Thursday before the bell. MA is estimated to bring in $0.71 a share and $983.24 million in revenues. High estimates are for $0.89 a share with possibly $1.03 billion in revenues. They have obliterated earnings four out of the last four times. It seems analysts have had a hard time counting all the money. COF and AXP warnings have put investors on alert though but those could just be company specific problems. On Jan. 11th, Deutsche Bank lowered their price target from $250 to $200 due to the AXP warning saying it expects likely near-term multiple pressure on MA shares. UBS on the other hand came out the same day and said many of AXP’s problems are company specific and that MA has no consumer credit risk and is a more globally diversified company.

Another noteworthy event happened the day before as Fidelity Investments lowered their passive stake in MA from 12.3% to 5.23%. But the most telling note IMO was on Jan. 8th by Calyon. Calyon made comments to clear up these misconceptions in the market about MA and said that MA is not in the lending business and does not issue cards and that banks use them to process transactions. MA has no credit risk or lending-related credit exposure. MA is not losing share to AXP and the foreign exchange is actually a benefit. Calyon is right, MA doesn’t issue credit cards, they simply process them and debit use has grown greatly and MA benefits from that trend but a consumer slow down and a sluggish holiday season could be the factor that either lowers guidance going forward or hits earnings performance now. MA’s technicals look great in the face of this vicious market selloff and I will be looking for a good strangle position going into earnings hopefully with a good pre earnings run beforehand.

ICE, ICE Baby!
ICE is just an incredible flexible marketplace. ICE reports earnings Thursday before the bell. ICE is expected to bring in $0.92 per share and $154.22 million in revenue. High estimates are for $0.95 a share and $159.5 million in revenues. ICE has largely met or exceeded consensus estimates for the past year. Volatile moves in gas prices and commodities bodes very well for future revenue growth and ICE’s management is one of the best in the biz. ICE’s mangement is very experienced and saavy and still looks to cut costs in many ways to streamline their revenue to profit. They are always looking for an accretive strategic alliance or buyout and reminds me of a restless shark. I remembered how management made CME pay up for CBOT even though there was only a remote chance that they would have been successful in attaining CBOT. A thorn in CME’s side for sure. On Jan 17, 18 and 21st, ICE futures established new electronic and exchange-wide volume records for three consecutive days. That is a great trend to start the new year and quarter for possible guidance. Although on Jan 17th, Wachovia issued cautious comments regarding monthly activity with lower volume by banks due to lower proprietary activity, followed by the next day with Goldman removing ICE from its Conviction Buy List but maintaining their Buy rating. NMX and ICE are constantly talked about as potential buyout targets for NYX, which is still looking to grow. ICE has shown volatility to earnings and to news and this week should be no different.

The Voracious VMW
VMW is expected to bring in $0.24 a share and $417.37 million in revenue. High estimates are for $0.28 a share and $435 million in revenues. VMW is announcing earnings on Monday after the bell. VMW is so dominate in their market it is estimated to own over 80%. MSFT is licking their chops at the market and its potentials and has made some recent acquisitions (Calista Technologies) showing their determination. VMW is in for a big fight even though their technology is over one year ahead of competitors. On Jan 25th, William Blair recommended waiting for a more attractive entry price given the current valuation with an initiation of a Market Perform. On a technical basis, VMW has shown strong support here at $80 with a base but once earnings is announced $80 will be an after thought as the shares should be volatile afterwards. Although VMW has a fairly large float of 376 million shares, the amount of shares short at 14 million shares is high and it has a large short ratio at 6.7 which could induce a short squeeze if they beat big with an upped guidance. Essentially priced for perfection (must beat and raise) with a high trailing P/E of 161, you can expect something big to happen after the bell Monday. On Jan 18th, ThinkEquity lowered their target from $90 to $70 saying that their checks indicate server virtualization has been slow to be deployed by enterprises in production environments. Additionally, checks confirm the compelling value proposition and VMW’s leading market share but the firm would wait for evidence of widespread adoption and a better entry point. On Jan 17th, BEST commented that they expect VMW to beat quarterly expectations expecting license growth of $283.5M for the quarter and guidance of $1.331B for 2008.

Consensus for 2008 is $1.33 Billion. On Jan 15th, Jefferies reiterated a Buy and said that they were bullish going into VMW’s Q4 results following channel checks suggesting business remains strong and finds the valuation attractive at current levels. They maintain a $129 target. On Jan 9th, VMW was initiated with a Buy and a $100 target by Lazard saying that they view VMW as the clear market leader in software virtualization but notes valuation leaves no room for error. That would be an understatement in this market environment. I call it the “Woodshed” environment where you get to survive by beating expectations and guidance.

An even weighted strangle with OTM options here going into the numbers would probably work well. I will be hawking that strategy but overall I must say I am bullish after reading into analyst checks and comments.

The Amazing Amazon
AMZN will be posting results on Wednesday after the bell and after the FOMC meeting. AMZN is expected to bring in $0.48 a share with $5.38 billion in revenue for consensus. The high estimates are for $0.52 a share and $5.58 billion in revenue. This was Amazon’s best quarter ever and I am really astonished about that revenue stream. In Seattle they have started to deliver groceries to homes with Amzon Fresh and it reminded me of back in the bubble days when they used to do that and now it is coming back around again. My wife believes there is a need for this service and I can see why. I could also see how flexible this platform can be for the future if Amazon really turns it up a notch and empower anyone to buy any one of their products (they basically sell everything under the sun) and have it delivered to your home with different shipping options charged accordingly. In one hour a $30 fee or within the week for $5. Who knows but what it does do is offer that flexible platform to leverage your brand and products and increase revenues and profits hopefully. After that, all they need to do is “kindle” or brand high profit margin products to their established customers (can I get Amazon milk and eggs please with that?) and voila you in-house the increasing whole profit margin from start to finish. Of course organic and healthy foods have higher profit margins (fits with their Amazon Fresh theme). Ah, home delivery of munchies and movies reminds me of the college days!

On Jan 23rd, Bernstein announced that they expected a strong quarter and that AMZN will report in-line EPS of 48c, helped by strong toy sales and a shift to online buying while keeping their Outperform rating. Inline in this environment will lead you to the woodshed, guidance could be what matters most. For future expectations on Jan 17th, Stifel said Amazon MP3, a DRM-free digital download service and a direct competitor to iTunes, has captured 4% of the market since its September 2007 launch. The firm believes Amazon MP3 can capture 20% market share by the end of 2009 and notes the downloads will play on any hardware device, not just iTunes. Shares are Buy rated. On Jan 15th, Pacific Crest said they believe in long-term expectations for revenue growth and margin are achievable and they find the current valuation reasonable. They do maintain a Sector Perform rating on the stock. On Jan. 8th, AmTech who carries alot of weight as a tech analyst initiated AMZN with a sell and a target of $69.

AmTech said they believed there was significant uncertainty surrounding the US consumer which will force AMZN to provide conservative 2008 guidance. Additionally, the analyst believes AMZN may have to ramp its 2008 marketing and tech and content spending given EBAY’s efforts. On Jan 4th, Merrill Lynch came out with cautious comments regarding upcoming guidance.

On Jan. 2nd, SBSH of Citigroup upgraded AMZN to a Buy from a hold with a target of $119 from $95. Citigroup believes the recent weakness has created an attractive entry point and that AMZN has one of best fundamental outlooks for 2008 among all U.S. Internet stocks. AMZN has beat 4 out of the last 4 times and looks to do it again as the trend to online shopping could be one reason why holiday retail sales were weaker than expectations or maybe AMZN was not immune to this larger trend, it remains to be seen. Guidance will be key and will make of break the stock.

The Diabolical Dolby
Huh? Dolby? I really like playing earnings names that are not so much in the limelight like the others. I played NTRI on its first big earnings pop after the first quarter in 2006 and it paid off very well as it was known but not yet mainstream. DLB is kinda like that. DLB has earnings on Thursday after the bell. DLB is expected to bring in $0.32 a share with $134.7 million in revenue. High estimates are for $0.36 a share and $141.6 million in revenue. They have completely annihilated previous earnings estimates especially on a percentage basis. On Jan. 25th, I received some great clues on DLB as Kaufman Bros. noted that MSFT PC data is a positive for DLB. Microsoft (MSFT) reported that the underlying PC hardware market grew 14%-16%, about three points higher than expected, Kaufman Bros. believes the data is an indication that Dolby will report a solid December quarter. I love finding hints from channels that have already announced. Kinda reminds me of my 5 bagger on INSP off of hints from Cingular earnings years ago. Although DLB does have its fair share of worry warts. On Jan 22nd, Morgan Stanley downgraded DLB from Equal Weight to Underweight saying that DLB shares have not yet priced in a recession. On Jan 7th, Piper chose DLB as one of its Digital Media Top Picks for 2008 along with AAPL and NFLX. Also that day, Kaufman Bros. noted that after the close on Friday, Warner Brothers announced that it would use Blu-Ray as the exclusive high definition format beginning June 1, 2008. They view this news as positive for DTS Inc (DTSI) and Dolby Laboratories (DLB) as both companies receive a royalty per Blu-Ray and HD-DVD player sold. On Jan. 3rd, Deutsche Bank said they believed infrastructure software valuations are near trough levels, near-term demand trends are solid and expectations for 2008 look reasonable. Verisign (VRSN), Citrix (CTXS), Websense (WBSN), McAfee (MFE) and Dolby (DLB) are their key ideas heading into 2008. The recent technological trend latley has been to endorse Blu-Ray and forget about HD DVD. This trend bodes well for Dolby and it seems after this recent selloff now back to previous breakout levels in November. If they beat and raise they should jump nicely. DLB has a float of 49 million and although it doesn’t have a huge short interest this stock can move, once volume jumps to nearly 3 million shares after earnings. I’ll be hawking the OTM calls and puts for a strangle going into the numbers hoping to catch a pre-earnings IV move.

This week, I will also be keeping a close eye on market sentiment and market internals by watching my TRIN-Q and TRIN-N and reading Dr. Brett Steenbarger’s blog for his unique advance/decline indicators, 20 day cumulative high-low line, and NYSE TICK analysis. Dr. Brett says this:

“We can look for an upturn in the cumulative high-low line to confirm a bottoming process in stocks. Thus far, we’ve seen two consecutive days in which new 20-day highs have outnumbered new lows: on Thursday (649 vs. 401) and on Friday (663 vs. 364). This week I’ll be looking for evidence of continued expansion in new highs vs. a resumption of the expansion in the number of new lows to gauge the likelihood of retesting this past week’s lows.”

The market internals and sentiment will have a big bearing on how individual stocks will react to their earnings before and after.

Other earnings of note which should be volatile are SNDK which announces after the bell Monday, ENR announcing before the bell Monday, MCD announcing before the bell Monday, YHOO earnings on Tuesday after the bell, TRMB after the bell Tuesday, BA before the bell Wednesday, CELG before the bell Thursday, YRCW before the bell Monday (should be real good), and BDK before the bell Monday.

Best wishes and please take care of yourself as we prepare for another volatile week,
optiondragon