This Boring Stock is Likely to Surprise Investors in 2016
As companies release their profit outlooks for 2016, some investors are getting worried about the six-year bull market. One of the largest companies based in my hometown just released its outlook and it sent shares skidding down toward 52-week lows.
But we’ve heard this story before. Management lowers expectations so the market doesn’t get too far ahead of itself only to consistently beat when results are reported. In fact, this company has beaten expectations in 11 of the past 12 quarters.
What more, I’m expecting one key trend to turn very soon, leading to big upside and a much stronger 2016 than anyone expects, which is why I’m getting positioned now.
Des Moines, Iowa-based Principal Financial Group (NYSE: PFG) provides 401(k) employer plans, annuity and insurance products to 20 million global customers, many of which are small and medium-sized businesses. The company has built an attractive position in the market by targeting firms that don’t generally show up on the radar of larger insurance companies.
While most insurance companies are dependent on investment income, Principal has focused on growing its fee-based revenue through asset management and retirement services. Since investment income and other rate-sensitive products can be volatile, fee-based revenue helps smooth the company’s top-line growth.
However, shares of PFG tumbled more than 5% earlier this month when the company’s 2016 outlook disappointed the Street. Principal said it expects just 2% to 4% revenue growth from its fee-based retirement and income solutions operations next year with a pre-tax return on net revenue of about 30%.
According to Credit Suisse, this equates to roughly $4.40 to $4.45 in earnings per share, while analysts had been expecting $4.49.
Yet, history has shown management to be consistently conservative with their estimates, and profits have beaten expectations by an average of 7% in the past 12 quarters.
And there’s another good reason to believe 2016 could turn out to be significantly stronger than management is forecasting.
The biggest question mark with regards to management’s outlook is the assumption of further U.S. dollar strength.
PFG has been aggressively positioning itself in emerging markets, especially China, Brazil and Chile. International business has been a huge growth driver, with a 20% increase in assets under management in the most recent quarter. However, earnings in this segment have taken a big hit this year on dollar strength and weakness in foreign currencies. While next year’s outlook calls for 15% revenue growth on a local currency basis, management expects just a 5% rise in dollar terms.
But if the greenback begins to weaken or even simply stops its upward trend, earnings could jump.
Weak international growth and expectations for higher U.S. interest rates have led to a surge in the value of the dollar versus foreign currencies over the past year. The U.S. dollar index has risen 10% in the past 12 months, but there is reason to believe it is running out of steam.
While the greenback jumped recently on the buildup to the Federal Reserve’s December policymaking meeting, it met considerable resistance at its March highs.
I think we may see a case of buy the rumor, sell the news with the dollar after next week’s FOMC meeting.
Furthermore, the Fed has made it extremely clear that strength in the U.S. dollar will be a factor in slowly raising rates. If the Fed fails to raise rates as quickly as the market expects, the dollar could fall as rates on other currencies become more attractive in comparison. This would also sap sentiment from the dollar and could return it to its long-term downtrend.
As I mentioned, any dollar weakness should result in higher earnings for PFG. Additionally, rising interest rates should help drive profits in rate-sensitive products and investments. Management is forecasting 9% revenue growth next year on its annuities and retirement products with a 57% pre-tax return on net revenue.
Share buybacks could also give earnings a big boost in the year ahead. In October, Principal Financial announced an acceleration of its 2016 capital allocation plan by authorizing share repurchases of up to $150 million. The company has bought back an average of just over $300 million in shares in each of the past four years, so I wouldn’t be surprised if it keeps this pace up as long as shares remain attractively priced.
Earn a 41% Annualized Return Without Buying Shares
Principal Financial Group usually reports fourth-quarter earnings during the last week of January or the first week of February. Rather than take a long position now, I plan to use a strategy that allows me to book a cash return immediately with the chance to buy shares at an even bigger discount or bring in more cash before the next earnings release. Specifically, I plan to sell puts on PFG.
Many traders shy away from this strategy, but that is a big mistake. Even relatively inexperienced traders can make a lot of money with it.
In fact, we just created a video that shows how our 32-year-old customer service rep — who has no real trading experience — made $274 in two minutes. Before you make up your mind about selling puts, please watch this.
With PFG currently trading for $47.23 per share, we can sell the PFG Jan 48 Puts for around $1.92 per share ($192 per contract). If PFG closes below the $48 strike price at expiration on Jan. 15, we will be assigned shares at that price. Since we received $1.92 in options premium, our actual cost basis is $46.08 per share, a 2.4% discount to the current price.
We want to make sure we have enough money in our account to cover this potential obligation. This means setting aside $4,608 for every put contract we sell — $4,800 for 100 shares minus the $192 we collected from selling the puts.
But if PFG is above $48 on expiration, which is 1.6% above the current price, we keep the premium for a 4.2% return in 37 days. This works out to an annualized return of 41%.
While there is no corporate news scheduled before the options expire in mid-January, any weakness in the U.S. dollar may drive the share price higher. The best-case scenario would be a marginal increase in shares past $48 and the opportunity to sell another put contract ahead of the fourth-quarter earnings report.
I think PFG will soon turn on strong international growth and dollar weakness, and selling puts lets us take advantage while we wait.
Note: Earlier I mentioned how our customer service rep — a trading newbie — used this strategy to pocket $274 in two minutes. After three years of listening to customers rave about how much money they were making — $800, $2,000, even $5,700 or more every month — she had to try it. Watch this video to see how easy it is.