A little-known software stock is set up well for the new year. Using options to trade it
A new year has a funny way of making investors feel both optimistic and anxious. Optimistic because the calendar resets; anxious because they may “take stock” of what they need to do better. That’s why a worthwhile New Year’s resolution isn’t “pick better stocks.” It’s to follow a repeatable investment process. Start with stock selection and make it evidence-based. The point of data analysis isn’t to discover a magical indicator; it’s to identify a small set of factors that have shown persistence, understand over what time frame they tend to work, and then combine them in a way that reduces reliance on any single signal. Many technical factors (trend, momentum, relative strength) tend to be more informative over weeks to months. They are therefore better suited to timing purchases and sales. At the same time, fundamentals (profitability, balance sheet strength, cash flow, durable growth) tend to be more informative over quarters to years and help identify businesses worth investing in for the long term. A practical process respects that: use fundamentals to define the “quality universe,” and technicals to determine the “timing and risk.” Finally, expect imperfection. Be prepared to make mistakes, identify them, and move on without fear or favor. A good start would be a three-step filter. Step one: “Is the business strong enough to own?” Look for durable sales growth, healthy margins, improving returns on capital, growing free cash flow, and balance sheet flexibility. I prefer to begin with fundamentals because it provides a list of companies worth keeping an eye on, even if it’s not the right time or price to buy them. You’ll notice that I did not list commonly used valuation metrics such as price-to-earnings or enterprise value-to-EBITDA at this stage, because those are gauges of price, not a business’s fundamental strength or weakness. Step two: Is the stock behaving as if investors agree? There is truth in price; weak price action may signal irrational investors are panicking, but it may also signal that something is lurking that the financial statements don’t reflect. Require the price to be above key moving averages and/or to be outperforming its sector or benchmark. Step three: Is the narrative already too crowded? This last step will help avoid chasing expensive stocks, and may help identify those that have become too cheap. Much like many diets incorporate a “cheat day” — intended to make a generally healthy lifestyle sustainable — a portion of a portfolio (sometimes called a “sleeve”) can also be allocated to “special situations” — instances where stocks may not strictly meet the filters but are still worth a modest bet, and may help satisfy the desire to paint outside the lines periodically. Today will not be a “cheat day”, however. Filtering publicly traded U.S. companies with five-year average revenue growth greater than 5% (roughly the real rate of inflation since February 2021), EPS growth greater than 8%, and ROIC greater than 12% that are also above their 50 and 200-day moving averages, I identified 98 stocks. One of the lesser-known is ePlus Inc. (PLUS). A “quiet compounder” in enterprise IT, ePlus is an IT hardware and software solutions provider to businesses seeking to modernize infrastructure, tighten cybersecurity, migrate workloads to the cloud, build out data-center capacity, and, of course, seek to incorporate AI. Over the past five years, the company has delivered 7% topline growth and 12% diluted EPS growth from continuing operations . A positive earnings beat helped the stock rally about 20% this quarter, though it has been in a tight trading range since Nov. 10. The trade I like the stock even after the 20% rally and the idea of a “buy-write” (purchasing the shares and selling upside calls against them), but with a critical caveat . Because the options prices for PLUS are wide, this is a situation that requires: understanding how an option should be priced based on the underlying stock’s price behavior; the use of limit orders; knowing how an option’s price should change as a function of changes in the underlying stock price. A fair value for the Feb. 20 expiration $95 strike call with the stock around $90 (it closed at $90.03 on Friday), is ~$2.70 per contract (a total of $270 in premium given each contract represents 100 shares). That option has a 38 delta . That means the value of the call will change approximately 38% with the PLUS share price. If the shares increase by $1, the value of that call will increase by 38 cents. If the shares fall by $1, then the value of those calls will fall by approximately $0.38, all else equal. An investor interested in a possible buy-write could purchase the shares, and assuming they buy the stock around $90, the current share price, enter a limit order to sell a 1 February $95 call at $2.70 for every 100 shares they bought. When options prices are wide, an investor needs to exercise patience. Use limit orders and wait for a fill (execution), understanding that it may not. That’s okay. It’s better to wait for the right price and risk not selling the option than to enter a market order and sell it at the wrong price. Most brokerage platforms should also permit an investor to enter this trade as a single order. Assuming your platform does, the total net debit would be $8,730 (excluding any commissions). $90 for 100 shares = $9,000 minus $270 net credit for selling one call at $2.70. DISCLOSURES: None. 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