Dear Bottarelli Research Reader,
EDITOR’S NOTE: I’d like to start off with an update on the upcoming Facebook IPO.
Back in January, we published a report titled, “Bottarelli Research’s Guide to Investing in Social Media.” In this report, we listed all of the upcoming technology and social media IPOs, complete with our “good, bad, and ugly” rankings. So far, our analysis has been right on the money.
With Facebook looking to go public this Friday, I want to offer you one final look at our investment strategy going into the most heavily anticipated IPO since Google.
If you recall, here was our original thoughts on how to successfully play Facebook…
Facebook is the undisputed dominant player in the booming global social media trend. No matter how you value the stock, this is a company you want to invest in. Yes, it’ll be over-hyped. And yes, it’ll be overvalued. But you still need to be invested. LinkedIn went public at $45.00 and traded over $100 in the first week. It capped out at $120. Facebook can see twice this return, if not more. If you can get into the Facebook IPO, buy it. If not, then buy the shares on the first day of trading. This could make you returns between 50% and 200% in 2012, depending on your entry and exit points. Once you’ve entered a position, we recommend selling half of your holdings when you reach a 50% return. Then, let your remaining half ride for higher gains.
As we approach Friday’s IPO date, we continue to stand firm to this strategy. But lately, there has been a rash of negative sentiment surrounding Facebook that’s worth addressing right now.
Bring Out the Facebook Bears
First off, the timing isn’t great. Facebook has decided to launch in the month of May, which is historically one of the worst market months of the year.
Furthermore, they’re launching at a time when political instability in Europe is causing the sentiment of the global markets to turn bearish. As of today, eight out of the last nine market sessions have closed lower, which certainly isn’t giving anyone a warm and fuzzy feeling.
But most of all, their valuation is now coming into question. For example, if Facebook values their IPO at $100 billion (which many expect), that means they’ll be trading at 40 times their 2013 estimated earnings from day one. Many value investors compare this to Apple’s 15 times earnings, and claim Facebook is overvalued right from the get-go.
In our view, this is the wrong comparison to make…
Comparing Apples to Kiwis
A better comparison would be to judge Facebook’s value to that of LinkedIn (LNKD – NYSE), which currently carries a trailing P/E of 745 and a forward P/E of 87.
Or how about Salesforce.com (CRM – NYSE), which carries a forward P/E of 65?
By definition, LNKD has been “overvalued” from the day it went public. Also, CRM has been overvalued (when compared to Apple) for years. You don’t see anyone comparing the valuation of LNKD or CRM to Apple, do you?
The bottom line is, Facebook is guaranteed to be over-valued. That we can say for certain.
But, when compared to the proper metrics, a high valuation isn’t something that’s out of the ordinary.
Mobile’s Red Flag
Another concern that has investors second-guessing their decision to take the Facebook plunge is the major threat to Facebook’s revenues represented by the rapid growth of mobile technology. Specifically, people believe that Facebook is unlikely to generate as much revenue per user from mobile devices as it does from the Web. And, since the entire world is going mobile, this is a red flag.
In our view, somebody will surely figure out how to successfully monetize the explosion of mobile technology. Worrying about the ability to monetize mobile technology is something that closed-minded individuals unable to see the big picture spend their days fretting about.
Here’s what you need to know…
Facebook’s growth over the past eight years has been staggering. We’re talking about a service that’s now used by one-eighth of the world’s population. Even better, their business model is brilliant because their users do all the work. That’s why Facebook enjoys a 50% operating margin.
The Bottom Line
While some of the recent concerns are valid to some degree, there simply isn’t another company like Facebook in existence right now. One way or another, you simply must own this company. They’re just too powerful to ignore. Plus, there are plenty of smart people out there who will figure out how to fully monetize Facebook’s massive user base. I trust they’ll get it done successfully. Having said that, our advice remains:
Buy Facebook on the first day of trading. Then, plan to sell half of your position at the 50% profit level. Based on how it trades in the weeks and months that follow, we will continue to offer you guidance. But the first order of business is to establish an entry-level position. Expect the stock to be volatile, so don’t bet the farm. Rather, establish an initial position to start and plan to add to your position on a dip (or sell at the 50% profit level) in the weeks and months that follow.
One Last Note
Speaking of Adam, I’d be doing my partner a disservice if I didn’t acknowledge the fact that he’s been on fire with his recommendations for our premium service, Bottarelli Research LEAPS. Back on April 9 in an alert titled “Two Out of Three Scenarios Could Trash this Bank,” he noted that unnecessary levels of risks were putting JP Morgan (JPM – NYSE) at serious risk. As a result, we entered the JPM December 45 Puts for $5.15 per contract.
Boy was this right on the money! I’m sure you’ve heard about JPM’s $2 billion trading loss. Surprise, who knew? Well, Adam did. As a result, our puts gained 94%. But that’s just the beginning. After making this JPM recommendation, Adam issued three more picks – currently up 16%, 40%, and 89% in our LEAPS portfolio. What a phenomenal four weeks.
If you’d like to begin receiving Adam’s valuable LEAPS alerts every Saturday morning, you’re officially invited to subscribe to Bottarelli Research LEAPS today. And given our recent profits, you’ll be very glad you joined us.
And on that note, here’s Adam…
Thanks for the lead-in Bryan. Talk about setting the bar high!
Quite honestly, the strong track record over the past few weeks stems almost entirely from the fact that we have seen, accepted, and prepared you for the market’s downturn.
If we want to keep on making money, we must continue with this clear and unsentimental analysis.
With that in mind, I have spent much of this week applying classic Dow Theory to the current market set up. Charles Dow’s work (as distilled postmortem by William Peter Hamilton, Robert Rhea, and E. George Schaefer) specified six (6) overarching rules:
- The market has three movements.
- Market trends have three phases.
- The stock market discounts all news.
- Stock market averages must confirm each other.
- Trends are confirmed by volume.
- Trends exist until definitive signals prove that they have ended.
Using today’s market, let’s run through these metrics…
Dow’s Rule #1
My work indicates that the American market has ended one of Dow’s Bullish Main Movements and is now beginning a bearish “medium swing.” I expect this pattern to last at least through late September, and possibly run all the way through election day in November. I project losses for the Industrials of least another 9%.
Dow’s Rule #2
Dow wrote of three phases of any given trend: Accumulation, Participation, and Distribution. These describe not only who is buying but also how their needs, wants, methods, and habits always impact price.
A quick review…
- In a rising market, the first phase is the flat bottom when only insiders (and congressmen) know its time to accumulate under-priced shares.
- The next phase is the sharp price spike that occurs when the rest of the world crowds in.
- The final phase is when the wise guys distribute their shares to the larger market and get the heck out of Dodge.
This third phase is exactly what my Stacked Signal System detected weeks ago.
Dow’s Rule #3
Dow often stated that the markets “discount” news. This one frequently confuses folks. How can anyone get ahead when inside trading is illegal and everything known is priced in?
It’s easy: Just refer back to Dow’s second rule. Even in this age of 24/7 news cycles, the distribution of information is never uniform. Most of the world is kept in the dark, while a few insiders always seem to know exactly what’s going on.
Fortunately, sufficiently sensitive technical analysis can alert us to the wise guys’ initial movements in and out of stocks, ETFs, and indexes.
Case in point: JPMorgan Chase waited until late last week to tell the world it was struggling with a multi-billion dollar trade that went wrong. But, my system warned of a sell-off in this sector weeks ago. This indicator allowed our premium LEAPS members to profitably short both JPM and GS.
Dow’s Rule #4
Most analysts (and virtually all cable-TV talking heads) misuse the Dow Industrial 30 Stock Index. Charles Dow created this list as a leading indicator.
But, are these factories selling product to end users? Or, is inventory just building on shelves?
To answer this question, Charles Dow would look to the list of publicly traded steamship and rail companies. If he noticed increased volume, then this might confirm product billable deliveries and thus confirm a viable rising trend.
The same rule works backward. We now have a Sell Stack showing on the Dow Jones Transports (TRAN). The decline in these shipping stocks confirms our initial sell signal from the Industrials.
Dow’s Rule #5
Trends are confirmed by volume. This one is tricky too. If you look to both the Industrials and Transports charts (above), you see a fall off in volume over the past four weeks as the Sell Stacks locked in. But, the moment we shift from quiet professional selling to a mass exodus, you’ll actually see volumes spike.
Dow’s Rule #6
Charles Dow was no muddy mystical believer in luck or animal spirits. Rather, he was a firm believer in measurable reality as the ultimate indicator.
His final rule was that trends exist until definitive signals prove that they have ended. This is where Bryan and I frequently differ from many other analysts. We know the difference between what ought to happen in a given circumstance, and what is happening right here and now.
That’s why we remained long the markets for several months despite receiving early indications of a potential sell-off. It’s also why we continue to recommend select long plays.
But let’s be clear: Dow’s Industrial and Transport Indexes are both giving us clear signs that the previous rising trend has been broken and a new, mid-term falling trend has begun. This could strip away another -9.14% from the former and -11.34% from the latter.
How To Play It
Last week, we advised that you place the industrial, financial, and retail sectors on your watch list and purge many of these shares from your portfolio. This week, you need to place these additional 20 stocks on your watch list as well. They’re all at risk of losing 9% to 11% in the near term. Here are these at-risk names:
- Alexander & Baldwin (ALEX – NYSE)
- Alaska Air (ALK – NYSE)
- C.H. Robinson (CHRW – NYSE)
- Con-Way Trucking (CNW – NYSE)
- CSX (CSX – NYSE)
- Delta Air Lines (DAL – NYSE)
- Expeditors International (EXPD – NYSE)
- FedEx (FDX – NYSE)
- GATX (GMT – NYSE)
- JB Hunt Transport (JBHT – NYSE)
- Jet Blue (JBLU – NYSE)
- Kansas City Southern (KSU – NYSE)
- Landmark (LSTR – NYSE)
- Norfolk Southern (NSC – NYSE)
- Overseas Shipholding (OSG – NYSE)
- Ryder (R – NYSE)
- Southwest Airlines (LUV – NYSE)
- United Continental (UAL – NYSE)
- Union Pacific (UNP – NYSE)
- United Parcel Service (UPS – NYSE)
For those of you who wish to take a more aggressive stance, consider this…
A Cheap Way to Short the Entire Sector
Here’s the chart for the iShares Dow Jones Transportation Average (IYT – NYSE). This fund seeks investment results that correspond to the price and yield performance of the Dow Jones Transportation Average Index.
As you can see, we have the same Sell Stack here as with both the Dow Industrials and Dow Transports. Therefore, our targets for this ETF are:
- Probable: $86.52 (-5.43%)
- Reasonable: $83.58 (-8.67%)
- Possible: $80.44 (11.99%)
A select, at-the-money put contract against the IYT stands to gain at least 40% by this summer. A serious market slide might easily double those gains.
Barring any breaking news, I will continue my analysis of the most at-risk transport stocks in Bottarelli Research LEAPS this weekend. I’ll be recommending that LEAPS members purchase put contracts against the most endangered transport player.
I hope to send this winning play to you as well.
As always, the charts tell all.