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A to Z – Zimmer Holdings

December 5, 2006
tags:

Many thanks for the positive response I’ve gotten about the blog. I’m thrilled.
I can’t promise that this will be a daily thing, but I’ll try to keep something interesting on here with some degree of frequency.

I thought I’d jump to the other end of our list. Zimmer Holdings. Who ever heard of that one? Not me. But maybe that’s a good thing. Isn’t it a good thing to be in a stock before it’s all over the headlines? In fairness, it trades about 8 million a day, so obviously someone knows about this. But you get the idea.
I’m looking at this because it seems there is something of a comeback under way. Not a drastic, obvious one, but a re-strengthening all the same. After a very impressive run up into mid ’04, it moved sideways into ’05, fell from grace and moved downward, finally finding relief this summer after a somewhat dramatic move below 60.
(Click on imagine to see it bigger)

Looking at the fundamentals:

Financials look generally good. ROE is a touch lower than we’d like, but still in the ballpark.
Sales over the last year is lower than the 25% we want to see, but the Earnings growth still looks good and above the annual average over the last 3 and 5 years. I think we can take this to mean that the company is run well and efficiently.
It is noteworthy that the short interest is steadily decreasing since August. Less and less people are bearish on the stock.

On the Estimates Page we see that next quarter’s earnings are expected to be slightly less than this one and would under perform the Industry’s growth. 5 year growth % is 16, less than the 25 we’d like to see. The analysts are split between Hold and Buy, whatever that’s worth.
One thing that strikes me as potentially very good for us is that the P/E on the current year EPS is 23, considerably lower than the Industry group average of 34. So despite the fact earnings growth is clearly slowing(projected Earnings growth is 16%, Historical average for 5 years is 26%), the stock is trading at a considerable discount to its group.

It is important to consider that the Big Chart ranking for the group has been in the red and falling for the past month. In that time, however, the group’s chart itself has been rising. What this means is that the group is, in fact, moving upward but with less strength than the rest of the market. Wouldn’t it be good to be nicely positioned in a stock of this sector when it does roll back into favor?

Getting away from all of that fancy talk, let’s look at the daily chart. As you can see on the the 5 year chart, the 72.50 line seems quite significant. After a panic sell off and drastic rally over the summer, the stock consolidated for a few months and then drifted up to nuzzle itself under that line. With no drastic move or volume, it moved above that line and has used it as support now for a month. Notice the high volume day on 11/20. Sellers tried to take it down, but the buyers stepped in to keep it off the lows of the day.

Technically, we have 3 green arrows in an an up trending stock with strong phase 2 scores. This is a buy. 75 has acted as resistance over the past month including yesterday when it almost broke above, but didn’t. The stock has consolidated sideways over for a month. Nevertheless, the bias is up and it is much more likely to break 75 than to break 72.50.

Look at the day after the recent earnings announcement. The stock opened lower moved higher on big volume to engulf the previous day. From then on, it has stealthily crept upward. In periods of calm, sideways to upward movement like we’ve had recently here, you can be sure that people are buying and not selling. Look on the Insider trading page for the Institutional Activity. 1,318 Institutions own 76% of the shares outstanding.

So where’s the target? If the relatively low P/E tells us anything, it could easily be above the stock’s all time high at 90. But it’s not exactly the most beautiful chart. Is it? With the overall market sending up some red flags lately, it’s hard to get that ambitious with this stock right now. Though we are now above all price action for the past year, there is still some overhead supply from ’04/’05. Looking at the most recent price action in that area, it seems very reasonable to shoot for 80 in the short term. There’s not a whole lot of obvious resistance between here and there. That wouldn’t be a very exciting stock play, but for an option play, perhaps.
But it comes down to risk/reward. Whether you’re playing a short term move to 80 or a long term move to 90 or 100, the downside risk as we see it now is 2.50. That’s a good, well defined situation. You might even use the current up trending support line to get you out earlier than that if it’s not moving up.

Here’s one way of playing it. January 70/75 Bull Call spread.
Buy Jan 70 Call for $6
Sell Jan 75 Call for $2.30.
That makes a net Debit of $3.70. That’s the max loss potential. However, at 72.50, the intrinsic value of the 70 call will be 2.50 and the time value in both options will add a bit more, so it would be very unlikely to close this trade for less than 2.50 if we were to exit on a break of 72.50. If it closes above 75 in January, that would give us our maximum profit potential of 1.30. (The spread is $5 wide between the two strikes, and we paid 3.70 for the position). To put it more clearly, we purchased the right to buy the stock at 70. We sold someone else the right to buy the stock from us (an obligation we’re taking on) at 75. If it closes above 75, they’ll excercise their right and we’ll excercise ours. That’s a $5 profit minuse the net debit we paid for the options spread. It would give us a 35% return if the stock moves up $.28 from where it no sits in 45 Calendar days. Not bad at all.
Our break even price would be 73.70, currently below us.
This is the power of advanced options strategies. A bit more complicated and must be used intelligently, but you can use them for great leverage without the crazy risk people associate with options.

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