Sometimes Bad News Means Good Buys
Nobody likes to see negative news on stocks they hold. It tends to send them down sharply.
But those looking to establish new positions, or to bulk up olds ones, often cheer the event. That was certainly the case this week as Energy Transfer L.P. (ET) got hammered on news of an FBI probe into possible bribery regarding approval of its Mariner East pipeline project back in 2015.
The negative reaction was instantaneous. ET fell from a month earlier peak of near $13 to as low as $10.84 before recovering slightly. It closed on Thursday a bit over $11.
Stories like this, involving major investigations, tend to take long times to play out. Often there is no serious damage. Other times there are real costs, but they are often more than fully discounted by the initial sell-off.
The chart action of Equifax (EFX) and Boeing (BA) helps illustrate how shares react to major negative events. EFX took a huge hit from its 2018 data breach. It plunged from nearly $140 to south of $90. Following a few months of churning, it took off again. Eleven months after the news, EFX was at a new all-time peak near $149.
Boeing's problems were much more serious than EFX's. The two crashes killed hundreds of people and caused the grounding of all 737 MAX 8 aircraft worldwide. Despite billions in financial damage and a real hit to its reputation, BA shares have held up remarkably well.
Energy Transfer's problem is nowhere near as serious as either of those other two. It may result in nothing. It could require ET to pay a fine. Either way, the sell-off in ET shares appears way overdone.
ET's average price-to-earnings, or P/E, has been 14-times. A typical yield ran about 5.74%. At its Wednesday close of $11.16, those numbers were 8.3-times and 10.93% respectively.
A regression to the mean valuation rebound could easily send ET bacxk towards $21 by the end of 2020. Achieving that goal would provide over 100% in total return over the coming 15-months.
I'm not alone in that viewpoint. Yahoo Finance calls ET very undervalued. Its 12-month target price sits at $20.84, accompanied by a 10.93% current yield.
Independent research from Morningstar carries ET with its highest, 5-star, buy rating. It notes its generous yield, low price/sales and low price/earnings ratios. Morningstar's estimated present-day fair value for ET sits at $22, a full 97% above its Wednesday quote.
Want to play ET, but at an even better entry point? Consider selling some of its Jan. 21, 2022 expiration date puts with $12 or $15 strike prices. Actual bid-ask, and last sale prices, with ET at $11.22 are shown below.
Worst-case, forced purchase prices would drop to either $7.95 or $8.73 respectively. That means ET could fall by from 22% to 29% from $11.16 without causing a loss. Those are amazing margins of safety.
Maximum profits on these, or any other option sales, is always keeping 100% of all premium received up front. In these examples that would equal either $405 or $627 per 100-share commitment. That is huge bang-for-the-buck on such a low priced share.
Future stock market action can never be guaranteed.
That said, owning ET at either of the two break-even prices involved would have been a winning position 100% of the time dating back more than three full years.
Long-time readers of my Real Money Pro columns know I, and my followers, made a lot of money with EFX last year. It's time to do the same with Energy Transfer now. Starting out with a better than 10% yield makes it very easy to generate very substantial total returns.
At the time of publication, Price was long on ET shares, short ET puts.