What Are Traders Watching Now?

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In this edition of the Alpha Letter, we cover:

  • Stocks & Options: Our list of momentum stocks to watch

  • Real Estate: What will investors settle for to get in the most desirable markets?

  • Undervalued stock idea: An undervalued retailer that hasn’t filed its financials

Stocks

Momentum stocks were the name of the game in 2020. Stocks like Peloton, Tesla, and Zoom skyrocketed for most of the year, way past the point of reasonable valuations. Part of the reason they did so well was the market’s obsession with momentum stocks in 2020.

New investors poured into the market throughout 2020 and wanted to ride the wave of the “next big thing”. When FOMO (fear of missing out) is high, momentum stocks do really well. Everyone’s chasing what’s hot and new buyers coming to the table keeps the action going.

The great thing about momentum stocks is that they don’t have to be in a particular sector or industry. In 2020, momentum stocks were mostly tech and anything that benefited from the work-from-home trend. But this year, many of those names have cooled off significantly. Zoom and Tesla are far off their highs investors pivoted to the new momentum arena: SPACs.

SPACs were great momentum plays for a while, but they’ve cooled off significantly. The chart below is the 6-month performance of Clover Health (CLOV) which perfectly showcases the rotation into SPACs as they heated up and the subsequent rotation out of SPACs. 

Traders are always rotating into and out of new momentum sectors. The idea is that when one sector gets too hot and overpriced, the vast majority of people start selling. Theoretically, that money flows into a new area that’s undervalued. 

What are traders watching now?

While we think that overall the hot trade in the market right now is reopening plays, there are all sorts of momentum opportunities. Typically, to identify momentum opportunities, we look at underlying option activity. Heavy call buying volume, especially out of the money calls, will tell us that a stock is a momentum play.

Of course, this isn’t always the case, so you’ll need to do further research after finding a stock with heavy OTM call volume. But here are a few names to look into that are experiencing extremely high call buying. 

  • FSLR - $110 call expiring January 20, 2023 - experienced extremely high call volume Thursday. It appears someone placed a very large order for the long-dated calls. We also noticed extremely high volume in the $88 call expiring today (FSLR closed at $87.15 Thursday).

  • SNAP - Several strikes experienced much higher than usual volume Thursday. The $57 call expiring on 4/30 saw volume of 1,051 contracts, over 4,000% more than the average of the previous 10 days. The $57 call closed at $3.85. We also saw extremely high volume in the $57.50 call expiring Friday. Surprisingly, volume in the far out-of-the-money $74 call expiring today was 2,205 contracts, about 2,500% above the 10-day average.

  • DKNG - After a steep pullback over the last three weeks, I believe investors are getting ready to step-back into sports gambling names like Penn and DraftKings. The call buying Thursday was very heavy, with many of the May 7 calls trading hands more than ten times as often as usual.

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Real Estate

How low of a yield will investors settle for to be in one of the most desirable markets on Earth?

I found this 18-unit apartment building in Venice, California on the market for a 3.27% cap rate. The units are beautiful, it’s within one block of the beach, and renters pay top dollar in one of the most demanded areas in the country.

Of course, that doesn’t come cheap. The seller is asking for $7.395 million, or about $410,000 per unit. With the current financials, your cap rate would be 3.27%. 

Last year, the owner brought in a total of $404,556 in gross rental income, or $1,872 per unit. Total expenses were $150,938, so the owner netted $253,717.

Would you pay $7.395 million to make $253k per year?

In a previous issue, we showcased a small hotel with a 20% cap rate. Obviously, there’s a lot that makes up that difference between offering 20% and 3%.

For one, the small hotel would require an owner-operator who would do a lot of the work to run the hotel. A high cap rate is necessary to incentivize someone to basically buy a job for themselves.

This apartment building likely requires little work from the owner. Maintenance is outsourced, and landlords rarely have trouble filling units. You can probably count on near 100% vacancy for this apartment.

The other main factor to consider is the location. Cap rates are driven down in markets like West Los Angeles because the risk is so low. People will always want to live in Venice. It’s extremely unlikely that the new owner will have to write this investment down ever. In fact, whoever buys this building will likely be counting on high appreciation in value as part of their model.

The question is: would you rather have a very expensive, low-yield asset that’s extremely safe, or take your chance with a less expensive asset that will either yield a very high return or high loss?

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Stock Idea

Do you like making stuff with your hands? Are you a craftsman? And do you like undervalued stocks that haven’t filed their financials in two years? Meet Tandy Leather Factory (“TLFA”).

Tandy Leather Factory is a retailer and wholesale distributor that sells leather and leathercraft items out of a network of over 100 retail stores. The stores are located in 42 U.S. states serving individual customers, wholesalers and manufacturers.

The run down:

  • Tandy Leather Factory has a market cap of $40 million and an enterprise value of only $30 million.

  • The Company has not reported its financials since Q1 2019 due to a restatement of financials from valuation and expensing costs associated with its inventory.

  • Despite the stale financials, business is still ongoing. In 2019 the Company reported revenues of $75 million. Profitability for the corporation has not been given.

  • In prior years Tandy has historically generated $10 million in operating income and $5 million in free cash flow.

  • Tandy released preliminary results for Q1 2021 two days ago with sales of $21.3 million (increase of 23.6% y/y) and positive double digit sales out of its three channels of distribution (retail, web and commercial).

  • Debt is only $0.4 million with a cash position of $10.9 million.

We suspect the Company will work through its updated financials sometime in 2021 giving investors a better sense of what is going on when released.

Business appears to have stabilized and cash has been generated from the end of 2021 (estimated $1 million in cash flow). In addition the ecommerce imitative seems to be taking off which should resonate well with investors in this digital first world.

Ms. Carr added, “We are particularly pleased with the strength of our web business, which has held firm even after our physical stores have reopened from the initial Covid-19 shutdowns. This has been driven by the many digital initiatives that we implemented throughout 2020 including a new web platform, a centralized order fulfillment capability, a customer call center and investments in digital marketing. Likewise, our new Commercial channel has also shown strong growth, reflecting the resonance of our tailored product and service offering with both new customers and large legacy in-store customers.”

If Tandy has gotten on the right feet they could theoretically start generating the same kind of operating income they have in the past. With an enterprise value of $30 million this would represent an EV/EBITDA of 3.0-6.0x (assuming $5-10 million in EBITDA).

Risks:

  1. Financial results are delayed even further than investors expect

  2. Leather goods and crafts continue to decline in popularity

  3. If comparable store sales fall there will be negative operating leverage

  4. Management turnover has been high which has likely disrupted business

Alpha Thought

What we are reading

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