This Market Dominator Should Hold Up Well in a Shaky Market

It’s been an ugly start to 2016. The Dow Jones Industrial Average posted its biggest opening-day loss since 2008 after a weak manufacturing report from China triggered a big drop in Asian and European markets. A meager rebound Tuesday was followed by another steep sell-off Wednesday on a drop in oil prices, continued concerns about China and news of a hydrogen bomb being tested in North Korea. 

Whether this is a short-term correction or prelude to something worse, it’s a good idea to start looking for quality companies with dominate market positions and strong balance sheets that can weather a downturn. 

New Growth Driver Should Bolster This Market Dominator

A management shake-up and revenue miss sent one of my favorite best-of-breed stocks into value territory. Not only does this company dominate its existing market and have a rock-solid balance sheet, but it’s expanding into a huge growth market. 

F5 Networks (NASDAQ: FFIV) is the leading player in the Application Delivery Controller (ADC) industry with 50% market share, more than twice its nearest competitor, Citrix Systems (NASDAQ: CTXS), which has approximately 20% of the market. 

F5’s core service is load balancing, or distributing Internet traffic across multiple servers in a data center. This makes for more efficient use of resources and faster application performance. According to management, this focus puts the company in a position to take advantage of several key shifts in tech applications like mobile banking and virtualization.

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The company’s fundamentals are very attractive. It has $774 million in cash on its balance sheet — about 11% of its market cap — and no debt. It also boasts double-digit annualized growth in free cash flow over the past five years. 

While F5 doesn’t pay a dividend, management has bought back an average of nearly $630 million worth of shares a year in the past two years, reducing the diluted share count by almost 8%. 

Despite these positives, shares have been under pressure of late. 

In the company’s fourth-quarter earnings report, released in late October, earnings jumped 17% to $1.84 per share, beating estimates by a dime. Sales fell short of expectations, though. Revenue of $501.3 million was up 8% year over year but below the Street’s estimate of $506.5 million, and first-quarter guidance also disappointed.

This sparked the most recent leg lower in the stock, although it has been in a downtrend since summertime with shares nearly 30% off their late-July peak. 

Investor sentiment seems to have soured under the leadership of Manny Rivelo, who replaced John McAdam as CEO five months ago. But Rivelo resigned last month for personal conduct reasons, and shares spiked 3.6% in one day when investors learned McAdam would retake the helm as interim CEO until the board can find a replacement.

Analysts at RBC Capital note F5’s cash-rich position and falling stock price make it an attractive takeover target, while Pacific Crest Securities postulated Rivelo’s departure could make the company more likely to seek a strategic buyer.

While I also think F5 is a good takeover candidate, I’m more interested in a huge and tangible growth driver. 

Network security looks to be a major opportunity for F5 after the acquisition of Versafe in 2013 and Defense.Net in 2014. The company is now aggressively bundling security products and services in with its other product sales. 

As seen in the chart below, 41% of product sales in fiscal 2015 included a security upsell — up 22% from the year before. 

FFIV Chart

The ADC market is solid, with analysts estimating it expanded 5% in 2015. But the data center and virtual security appliances market has far more upside at this stage in the game. In fact, IHS expects sales to jump 42% over the next four years. With its relatively new security products, F5 can capitalize on that growth by helping clients reliably and securely connect their systems to their networks. 

Generate 26% Even if F5 Networks Stays Flat

Shares of FFIV are currently trading at $95.02. Rather than take a position immediately in this shaky market, though, I want to employ an options strategy that could allow us to generate a 26% annualized return without even having to buy the shares. 

Selling put options on F5 means I collect a cash premium now and agree to buy the shares at the option’s strike price if they close below that price on the day the option expires. If the price of the stock is above the strike price at expiration, however, I keep the cash premium and do nothing. 

(If selling puts is out of your comfort zone, there’s something you need to see. Our 32-year-old customer service rep — who has no real trading experience — made $274 in two minutes by doing just that. Watch her go through it step by step in this video.)

We can sell the FFIV April 95 Puts for $6.35 each ($635 per contract). If FFIV closes below the $95 strike price at expiration on April 15, we will be assigned 100 shares per contract at that price. Since we received $6.35 in options premium, our actual cost will be $88.65 per share, a 6.7% discount to the current price and 6.2% below the 52-week low. 

We want to make sure we have enough money in our account to cover this potential obligation. This means setting aside an additional $8,865 for every put contract we sell — $9,500 for 100 shares minus the $635 we collected for selling the puts.

If FFIV is above $95 on expiration, we keep the premium for a 7.2% return in 100 days. This works out to an annualized return of 26% — without shares even needing to move higher.

FFIV reports Q1 results in late January and has a history of beating expectations. Right now, earnings are expected to come in 3.2% higher. But with growth in security, there’s a good chance for stronger-than-expected quarterly results that could push shares higher. 

If FFIV fails to stay above our strike, we can hold shares and sell call options against the position. Market leadership and strong cash flow should support shares, while any decision from the board about a new CEO could boost investor sentiment. 

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 they are doing it.