Market Overview
Before we dive into this week’s idea, I wanted to clean up our SHLS and ASO positions from last Friday’s January expiration. Fortunately, both SHLS and ASO rallied nicely on Monday, pushing them right back to the levels we bought them last month, while our calls expired worthless. This was great situation, and I am going to move on from both. To do so, we need to:
Sell the SHLS stock position
Sell the ASO stock position.
Moving on …
It was hardly smooth sailing for traders last week, as the indexes got hit hard on Wednesday and Thursday, and then roared back to life on Friday. By week’s end, the S&P 500 had lost 0.66%, the Dow had fallen 2.7%, and the Nasdaq had risen by 0.65%, which was its first three-week win streak since August.
This week earnings season ramps up in a big way.
The Stock – Toll Brothers (TOL)
Why the Strength
Toll Brothers is one of the major homebuilders in the U.S., with a leading position in luxury homes in upscale communities. While the residential property market has underperformed in the past year, partly due to rising mortgage rates, the market for luxury housing has outperformed, which makes sense as some 20% of buyers in this segment pay in cash with no regard for rates, with others putting much more than 20% down.
Last year was a milestone for Toll Brothers, which set records across several key metrics: In fiscal Q4 (ended October 31), Toll Brothers reported sales of $3.7 billion that rose 22% from a year ago (and nearly 50% from the prior quarter), plus per-share earnings of $5.63 that easily beat estimates and nearly doubled. The results were even more impressive given that they were achieved against a nationwide backdrop of lower home sales, rising inventories and higher rates.
Of course, there’s no doubt a slowdown is underway—Toll’s new orders in the quarter were down a whopping 56% from a year ago (!), though, to be fair, Toll’s total backlog value was $8.9 billion, off just 7% and much better than many of its peers; plus, 25% of that backlog will be paid in full and 90% of it is to be delivered by October. Management also indicated the firm has sufficient land under control to increase community count by 10% in fiscal year 2023, which should allow it to generate “significant” cash flow. And with mortgage rates having backed off some, and with lower input costs expected, many analysts expect better times ahead for the homebuilding sector, with a major bank just upgrading Toll Brothers based on these factors. Shareholder-friendly management (1.4% dividend yield; share count down 8% from a year ago) is a cherry on top.
Technical Analysis
TOL hit a high point in December 2021 in the pandemic’s wake as the nationwide home buying spree was in full swing. Shares peaked at 75 but then reversed in early 2022 when rising rates and the bear market caused the buyers to vanish; the stock hit a low point at 40 last June and, after a brief bounce, fell back to retest that level in October. The uptrend since then has been fairly persistent (up seven of the past nine weeks). Stop – 48.5
The Covered Call Trade
Buy Toll Brothers (TOL) Stock at 56.5, Sell to Open March 55 Strike Calls (exp. 3/17) for $3.50, or a Net Price of 53 or less
Static Return: $200 per covered call (3.77%)
Breakeven: 53
Covered Call Return (if assigned): $200 per covered call (3.77%)
Please note, the stock and options prices will be moving throughout the day, so these prices are simply an approximation of prices that you should be able to achieve.
However, the important component of this equation is that the stock price paid, minus the premium received via the call sale, equals the Net Price, or 53 or less. (In this case 56.5 minus 3.50 = 53. Or another example is you could pay 56 for the stock and sell the call for 3, which also equals 53)
For every 100 shares of stock you buy, you can sell 1 call. For every 200 shares of stock you buy, you can sell 2 calls. And so on …
Open Positions
If our stop is hit, I will send an alert giving detailed instructions on how to exit the trade. But don’t get too worried about setting the stop. I will manage that for you.
The next Cabot Profit Booster issue will be published on January 31, 2023.
