As banks learned a decade ago during the financial collapse and General Electric is learning now, investors like simple businesses. The more complex a company is, the more investors want to break it up.
A few companies, especially over the last few years, have really driven this point home. The best performing stocks over the last few years, as the recovery has started to slow have been simple businesses. Think Procter & Gamble or McDonald’s. These are the kinds of companies seeing investors flood in.
But there’s another company just as simple and easy to understand that often flies under the radar. Well, investors got their hands on it too… and it looks like they’ve sent shares up too high.
Waste Management (WM), if you live in North America, is about as recognizable of name as Coca-Cola or McDonald’s. The waste services company operates across the U.S. and Canada in a near monopoly. It does have competition, many smaller local services. But its landfill business still gets its cut from them.
WM has nearly 250 landfills across North America, 130 of which capture methane gas and burns it turning these garbage piles into mini power plants. The company also operates materials recovery facilities in 103 locations and a 14,500-truck strong fleet, more than half of which are natural gas powered.
In short, the company is huge… and everywhere. If you look at its operation map, you can see it covers nearly every state… and much of Canada:
This size and pseudo monopoly status has let it gradually increase dumping fees for its competitors and increase margins over time. Today, WM is one of the most profitable and consistent businesses in the market.
It nearly always beats analyst estimates, which have sent its shares straight up over the last several years. But just beating expectations can only take you so far. The company’s tremendous price appreciation from $50 to its current price tag of $113 over the last few years has left it a bit overvalued.
Right now, the company trades at 28.2 times its trailing 12 months of earnings and 3.2 times sales. Sure, it has produced steady growth, but only about 3% or 4% per year, not enough to justify these valuations. And investors seem to finally be noticing this glaring flaw in an otherwise perfect stock…
Here we have the company’s year-to-date stock chart. As you can see, it’s been a rather straight shot from below $90 to nearly $120 earlier this month. But notice the recent correction.
The company has been a dividend powerhouse for the last decade, growing its payments each year and offering yields north of 2.5% and even 3%. But with this recent price rally, those yields have dipped below 2%, which is not what investors want to see.
This short-term correction, as you can see from the blue line above, sent shares crashing through their 50-day moving average. They haven’t been able to break back above it in over three weeks. That means, this correction might just be here to stay.
The only place left for those share prices to go in the short term is down to that red line, the 200-day moving average. That presents the next support level. And there’s nothing between the current price tag of $113.50 and that $105 mark. This is our opportunity.
You don’t have to necessarily bet against Waste Management’s long-term success to play it either. This is just a chance to take advantage of a long-overdue correction, before the company’s shares start growing again.
Fortunately, there’s a perfect strategy for that…
A Strategy For Short Term Bears
A bear put spread is a type of options trade that involves buying a put option on a stock you believe is due to fall in the short term, and then selling a second put with a lower strike price.
The option premium from that second put helps offset the cost of the purchased one. This reduces the entry cost of the trade and therefore the total amount at risk.
This offset does come at the expense of capping the maximum potential profit. But for the case of Waste Management, that’s an easy tradeoff to make. WM is set to continue falling, at least down to around $105. But it definitely isn’t likely to completely collapse.
So, as you can see, this strategy presents the perfect risk/reward balance:
The company has an earnings announcement coming up toward the end of next month. If shares haven’t fallen by then, that could be the catalyst to send them down to that support line.
So, smart traders would keep that in mind when selecting which puts to use. Let’s look at a specific example of a bear put spread on WM using these criteria.
A Specific Trade on WM
Right now, a trader could buy a November 15 $115 put for $3.88 and sell a November 15 $105 put for $0.90 for a total cost of $2.98 per share. Since each put represents 100 shares of WM, that’s a total cost of $298.
That’s the total amount at risk. But for the trader to lose that, shares would have to expire north of $115 by mid-November. The recent correction continuing in the near term is far more likely, however.
If it does, and shares sink down to $105 – their next support level – this trade would pay off in a big way. To find that maximum profit potential, take the difference in strikes ($115 – $105 = $10), and subtract the cost ($10 – $2.98 = $7.02). Again, on 100 shares each, that’s a profit of $702 in less than two months.
In other words, if shares of Waste Management do come down just a little bit as both its valuation and stock chart suggest, this trader would see a profit of 236% on the amount he put at risk.
For a company that consistently and methodically churns out small sub-2% dividends, there’s simply no other way to triple your month in such a short amount of time.