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Many of the traders I talk to are wondering what Bill Ackman could be thinking.
Ackman is a hedge fund manager, the founder and CEO of Pershing Square Capital Management, which has about $11 billion under management. Ackman is considered a contrarian investor who tends to buy when companies are down, and an activist investor who sometimes takes a role in managing companies he invests in. He has achieved incredible success by some measures and has a reported wealth of about $1.4 billion.
Ackman recently shared a chart showing his performance with investors...
There is an obvious problem with recent performance. As Ackman explained, "The substantial decline in performance from August 2015 through March 31, 2016, is largely due to Valeant's decline..." Valeant is now the investment traders are talking about.
Ackman took a large stake in Valeant Pharmaceuticals International (NYSE: VRX) as the company was growing rapidly through acquisitions. The strategy largely relied on buying other companies and then raising prices, a tactic that we know was widespread in the drug sector. But regulators began to question the strategy after it was discovered VRX was using in-house pharmacists to potentially overbill insurance companies. Traders reacted to the news by selling VRX.
Ackman, however, responded to the news by raising his stake and taking an active role in managing the company with two seats on the board of directors. In the end, Ackman seemed to have concluded that Valeant, which took on massive debt to fund its acquisitions, wouldn't recover in a timely manner, and he sold his position at a loss of more than $4 billion.
After the selloff, Valeant is about 96% below its all-time high. It needs to gain 2,500% to get back to that level. Losses, as Ackman's performance demonstrates, have a large impact on returns -- an important lesson for any investor. The size of the gain required to break even is always more than the size of the loss. The difference between the two starts small; for example, a 10% loss requires an 11% gain to breakeven. But the gap grows much wider the worse the losses get: A 90% loss requires a 900% gain. A 95% loss requires 1,900%.
The math shows why it's better to take small losses than large ones. The current market is vulnerable to a selloff, but I also believe there are a number of opportunities among the most oversold sectors in the market.
Some of the oversold industry groups, like the energy sector, have already suffered bear markets. The decline in the energy sector has increased volatility, making some stocks attractive as income trades. That is particularly true of, Tesoro Corporation (NYSE: TSO), an oil refiner and retailer with operations in 18 states.
You may recall that I've written about TSO several times in Trade of the Day. I've also recommended selling nine put options on TSO in my premium newsletter, Income Trader:
As you can see, selling puts on TSO has led to consistent income for my subscribers. The company was even able to maintained profitability and its dividend throughout the downturn in oil prices, which should also support the stock price going forward.
Both the earnings forecast and the dividend yield indicate that TSO offers value. Based on this year's expected EPS and a price-to-earnings (P/E) ratio of 14.7 -- the five-year average for the oil and gas group -- TSO is worth about $84, near current prices. Using next year's estimated earnings provides a price target of about $100.
Technical analysis also supports an income trade in TSO this week. The chart below shows a bullish Income Trader Volatility (ITV) signal.
There are other ways to value the stock, too. For example, we can look at the three-year average yield, which is 2%. The current dividend, at that yield, offers a price target of $110.
I'm saving the specifics of my income trade for my premium subscribers, but if you'd like to get started selling puts, I'm here to guide you through the process. I'll tell you which trades to make and when. To learn more about receiving my trades, I invite you to click here.
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I've managed to find a trade this week that strikes the proper balance between risk and reward.