It’s a very rare stock these days that trades below their late 2008 – early 2009 absolute lows. That was a panic-driven, sell-everything environment that pushed most shares to outrageous levels that were unrelated to those stocks' true values.
What saved Knight Capital (NYSE:KCG) from that fate was its all-time record earnings of $1.94 during 2008. KCG did fall from $19.80 to $11 before rebounding to a 2009 high of $23.10 even as earnings slipped to $1.54 a share. Since that peak Knight’s share price had steadily declined to a new five-year low during Tuesday’s session.
From yesterday’s close of $10.79 I see very low risk and huge upside. KCG trades at a steep discount to tangible book value of almost $15 per share and boasts a nice balance sheet with only 19% debt as a percentage of total capital.
First quarter earnings came in at $0.33 versus $0.30 and well above consensus estimates. Zacks now expects $1.16 for 2011 and a ramp up to $1.46 in 2012. That leaves KCG at just 9.3x this year’s and 7.4x 2012’s expectation. While I don’t look for a high multiple on KCG, their previous trading history suggests 11.5 – 12.0 to be a more normalized P/E.
That would bring KCG back to $13.34 – $13.92 by year end and to a very nice $16.79 - $17.52 over the next 18 months or so. Both those targets may prove to be quite conservative in light of the fact that Knight touched $14.70 already in 2011 and peaked out at between $17 and $23.10 in each of the five previous years.
My guess is that portfolio managers have been dumping KCG to avoid showing it on their semi-annual statements. Nobody likes to admit they’ve held a poor performer so it’s easier to simply purge it before June 30 and avoid answering questions. If I’m right on this you may very well see a quick repurchase of these shares shortly after the quarter is over.
Morningstar seems to agree. They rate Knight with 4-Stars (out of 5) and see "fair value" as $19 per share. Standard and Poors is a bit more in line with my own projections with a 12-month target price of $15.
With KCG just pennies above a five-year low I’m a buyer of shares and a seller of puts out to January 2012.
Buy 1000 KCG for $10.79 /share
‘If Put’ Price
Margin of Safety*
STO 10 Jan. 2012 $10.00 Puts
STO 10 Jan. 2012 $12.50 Puts
* margin of safety = % the ‘If Put’ price is below the $10.79 trade inception price
Disclosure: Long KCG shares and short KCG options
Dr. Paul Price