New Trade – PG: Could Crest Soon

by Dan September 5, 2012 3:18 pm • Commentary

On many occasions we have discussed the concentration of strength among a handful of names driving much of the SPX and the NDX’s ytd performance.  For instance the top 20 weighted names in the SPX account for almost 35% of the entire index of 500’s weight.  A few of the largest companies in the world (AAPL, XOM, GE) are single-handily dragging up the broad market.

Proctor and Gamble is one of these sort of “Zombie” bellwether stocks that has not participated in the SPX’s 11.5% ytd to rally, despite being the index’s 8th largest weighted stock.  Before Pershing Square’s Bill Ackman took a $2billion stake in the consumer products maker in mid July, the stock was down about 10% on the year after recording 2 consecutive earnings disappointments on the heals of weak sales overseas.

In fact, in 2011, PG only got about 39% of their sales from North America, as the company has set their sites on emerging markets as their primary growth engine.  Investors this year have flocked to seemingly defensive companies likes PG with their solid balance sheets and healthy dividend yield.  The problems I see with this trade are first it is crowded, and second investors are less focused on fundamentals and more so on yield.  At some point in the near future, investors may soon be disappointed with stimulus efforts as they realize once and for all that they don’t stimulate growth, and re-evaluate some of these no growth holdings.

PG sticks out to me like a sore thumb, as analysts only expect the company to grow earnings in the mid single digits and sales in the low single digits for the next few years, while the stock trades at more than 17x this year and next’s earnings estimates.

As mentioned above, the stock has massively under-performed and while it is less than 1% from the 52 week highs made in March it is only up 1% on the year.  If the market breaks out to new highs, I expect stocks like PG which offer little by way of earnings growth to continue under-perform, but if we eventually get a pause from QE fever from investors, I would expect the market to trade more on fundamentals and would expect stocks like PG to still under-perform.  I just don’t buy the fact that an activist like Ackman can effect too much meaningful change in a $185billion market cap company.  I want to fade this recent strength and set up for the 3 rd consecutive earnings disappointment in late Oct.

TRADE: PG ($67.38) Bought Jan13 65/60 Put Spread for 1.15

-Bought 1 Jan 65 Put for 1.88

-Sold 1 Jan 60 Put at .73

Break-Even on Jan13 Expiration:

-Profits btwn 63.85 and 60 of up to 3.85, max gain of 3.85 at 60 or below.

-Losses of up to 1.15 btwn 63.85 and 65, with max loss of 1.15 at 65 or higher.