This Company Could Benefit From a Booming or Declining Economy
Some companies depend on economic growth for their success. Others can fare better when the economy slows. One company could do well in either environment.
That company is Ritchie Bros. Auctioneers Incorporated (NYSE: RBA). RBA sells industrial equipment and other durable assets through auctions and private brokerage services. The company sells a range of used and unused equipment, including earthmoving equipment, truck trailers and other industrial assets.
It also provides auction technology services for online bidding at live on site auctions. The company primarily sells equipment to its customers through unreserved auctions at 45 auction sites worldwide.
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In a booming economy, new companies will seek bargains at auctions. In bad times, companies might try to raise cash by selling off idle equipment. Either way, Ritchie Bros. stands to generate revenue. The recent earnings report shows the company’s potential and traders reacted by buying aggressively.
The company has an interesting history, “It was the 1950s and the three Ritchie brothers — Ken, Dave and John — had taken over the family furniture store in Kelowna, Britich Columbia (B.C.). Short on cash and in a bind, they took someone’s suggestion to hold an auction to sell surplus tables and chairs.
The following Saturday, they rented the local Scout hall and sold enough furniture to keep the bankers at bay. The sale was a revelation for the brothers. The auction convinced them to move on from the O.K. Used Furniture Store and try their hand at new line of work.
The brothers stumbled into the auction industry by circumstance, but the seeds were sown for continued success.
Ritchie Bros. Auctioneers has grown into the world’s largest industrial equipment auctioneer with more than 40 locations in 20 different countries.
Still headquartered in B.C., the company sold about $4.5 billion in equipment in 2017.”
Earnings Push the Stock Close to All Time Highs
According to Zack’s, “Ritchie Bros. came out with quarterly earnings of $0.42 per share, beating the Zacks Consensus Estimate of $0.37 per share. This compares to earnings of $0.33 per share a year ago. These figures are adjusted for non-recurring items.
This quarterly report represents an earnings surprise of 13.51%. A quarter ago, it was expected that this heavy equipment auctioneer would post earnings of $0.17 per share when it actually produced earnings of $0.16, delivering a surprise of -5.88%.
Over the last four quarters, the company has surpassed consensus EPS estimates two times.”
The stock soared to a level near its all time highs, forming a potentially bullish pattern.
A Trade for Short Term Bulls
As with the ownership of any stock, buying RBA could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for RBA
For RBA, the December 21 options allow a trader to gain exposure to the stock.
A December 21 $35 call option can be bought for about $4.00 and the December 21 $40 call could be sold for about $1.50. This trade would cost $2.50 to open, or $250 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $250.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in RBA the maximum gain is $2.50 ($40 – $35 = $5.00; $5.00 – $2.50 = $2.50). This represents $250 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $250 to open this trade.
That is a potential gain of about 100% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.