Traders sometimes overreact to bad news.
One of the most common occurrences of this is when a company reports lower-than-expected earnings or guidance, which causes the stock to sell off sharply.
If the earnings miss is isolated to that quarter, the sell-off creates a buying opportunity.
I think that defines the opportunity we have right now in the world’s largest chipmaker, Intel Corp. (Nasdaq: INTC).
On Friday, Sept. 7, before the open, the company announced that third-quarter revenue would be lower than management had previously expected. The stock sold off 3.6% on Friday, and then drifted lower on Monday with the boarder market.
In early September, they lowered that estimate to $13.2 billion blaming the drop on slowing demand for new PCs from businesses.
That is likely to be a temporary situation, and might even be caused by the upcoming release of a new operating system by Microsoft (Nasdaq: MSFT) that is scheduled for later this year.
Many businesses will want to wait to evaluate Windows 8 before deciding when to upgrade, which could cause a slowdown in their software and hardware buying plans.
Some companies may also be considering a switch to cloud-based operating systems or other alternatives to Microsoft products. The exact hardware they need could vary, but no matter what operating system they choose, the hardware will most likely require an Intel chip.
Intel produces about 80% of the chips used in the PC market. While the popularity of tablets is skyrocketing, there is no alternative to desktop and laptop PCs for most businesses. Tablets are not yet a serious threat to business PCs, and it seems unlikely they will become one for at least a few more years. Additionally, Intel plans to come out with a chip aimed at a new generation of computers that can act as both tablet and PC. The new chip is due out in the first half of 2013.
After Intel announced that it expected slow sales in the third quarter, analysts lowered earnings estimates for next year to $2.27 and estimated future earnings growth of about 12% a year. Some traders use the earnings growth rate to estimate what the price-to-earnings (P/E) ratio for a stock should be, a metric called the PEG (P/E-to-growth) ratio. They assume the fair value of the P/E ratio is equal to the earnings growth rate. If Intel traded at a P/E ratio of 12, the stock price would be $27.24, a 16% gain from the recent price of Intel.
At the current price, Intel is trading at about 10 times earnings and offers a dividend yield of about 3.7%. At this price, traders seem to have factored in slow growth. No one is forecasting that Intel will suffer a long-term, catastrophic decline in earnings. That means a stock with a P/E ratio of 10, a better-than-average yield, and steady sales opportunities are probably underpriced because traders overreacted to the news of a temporary slowdown.
Call options on Intel would allow traders to enjoy a significantly larger gain if Intel recovers. I think a recovery is likely at some time in the next six months making the April 2013 options the best way to trade this idea. Calls with a $25 strike price are trading at about $1.07, and the call would have an intrinsic value of $2.24 at the target price, a potential gain of about 109%.
When buying call options, a trader’s loss is limited to the purchase price of the option. The potential upside of more than 100% and small potential loss of a little more than a dollar a share makes this a low-risk, high-potential trade.
Action to Take –> Buy Intel April 2013 25 Calls at $1.10 or less. Do not use a stop-loss. Set initial price target at $2.20 for a potential 100% gain in seven months.
– Amber Hestla- Barnhart
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Source: Trading Authority
Amber Hestla-Barnhart does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of INTC, MSFT in one or more if its “real money” portfolios.