Buy and Hold… or Trade?
Applied Intelligently, Each Technique Can Make Sense
There is much to debate from both points of view. With Cognizant Technology Solutions (CTSH, Financial) either answer could be considered correct.
CTSH was formed as an in-house IT unit as part of Dun & Bradstreet (DNB, Financial). It came public in June of 1998 at a split-adjusted price of 84 cents per share. That is not a misprint. Original buyers that never sold now hold shares that, as of July 20, 2015, were up 7114%, at $60.68.
That is as good an argument for buy-and-hold as anyone could ever hope to present. I’m guessing, though, there are not many investors you simply held it for those full 17 years. To do that they would have needed to suffer through some breath-taking plunges along the way.
Cognizant peaked at $23.90 in February 2007, on its way to a 2008 nadir of $7.20 (both split-adjusted). Watching your statement value go down by almost 70% can make passively sitting tight appear mighty foolish.
Okay, that was the Crash of 2008. More recent history shows how tough 'doing nothing' can really be. The spring 2011, high of $41.70 led to a 35.7% decline, to $26.80, over just five months. It took about 2.5 years for that previous peak to be permanently left behind.
CTSH made what was then an all-time high right before an announced 2 for 1 split took effect in early 2014. Half a year later, the stock was down by 22.4%.
Those who sold near Cognizant's tops were able to repurchase the same positions later on, and much cheaper. The declines more than offset both taxation and trading expenses. They also soothed the soul versus stoically riding the elevator up and down over long periods of time.
The chart above shows how valuation analysis could have guided traders to maximize their results. In the post-recession, ZIRP world, CTSH has typically commanded a 20.9x multiple. All five ‘best buying opportunities’ reflected substantially lower than normal valuations.
The three red-starred periods, when Cognizant was due for some poor stock market action, were each marked by higher than median P/Es. Valuation was always the prime consideration in predicting future near-term returns.
CTSH is as high-quality as you can get. They sport a debt-free balance sheet, have no defined pension liability and rank in the single top percentile in terms of earnings predictability. Over the long haul, CTSH shares outperformed 85% of all firms covered in Value Line’s 1700-company main research universe.
Where does Cognizant fall in terms of present day value?
The company is expected to earn $2.97 this year, rising to $3.42 in 2016. That leaves CTSH at about a 20.4x P/E right now, but also at just 17.7x 2016’s projection. Forward thinkers have every right to consider CTSH as a relative bargain.
True believers with a bit of patience could own the stock here with a 12 – 18 month target price north of $71 based simply on a regression to the mean.
Option sellers can accomplish pretty much that same magnitude return by selling some Jan. 2017 $65 puts at $10.10 per share. The best case scenario would only require Cognizant to climb to at least $65 by the Jan. 20, 2017 expiration date.
If that occurs, put writers will keep 100% of all premium received. That would equal $1,100 per contract in this example. Break even drops down to $54.90 ($65 strike price - $10.10 put premium). The $5.78 per share cushion from the trade inception price provides an almost 10% margin of safety.
The worst that can happen is forced purchase of 100 shares (per contract sold) at a net cost basis that CTSH buyers haven't seen since early February.
Disclosure: Short CTSH Jan. 2017, $65 puts
