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This Warren Buffett Tech Stock Could Deliver a Big Gain

This Warren Buffett Tech Stock Could Deliver a Big Gain

While Warren Buffett is usually associated with value stocks, he does make trades in tech stocks and, as Investor’s Business Daily  reported,

“Legendary investor Warren Buffett has a big stake in StoneCo (Nasdaq: STNE), and this is just one reason investors should put this hot IPO stock on their watch lists.”

StoneCo is a profitable Brazilian payments firm. It’s a cloud-based payments processor, similar to Square or PayPal.

Buffett’s Berkshire Hathaway holds the second largest stake in the company with 11.8% of its shares. Other big holders include T. Rowe Price Associates, with a huge 24.1% stake and several Fidelity funds.

According to analysts, “Brazil’s political and economic climate are improving for the stock. President Jair Bolsonaro, who a runoff election on Oct. 28, took office in January with a pro-market agenda.

Last month economy minister Paulo Guedes promised to end years of failed state interventions in Latin America’s largest economy. Bolsonaro aims to enact sweeping free-market reforms.

Hopes for a rebound in Latin America’s largest economy helped lift rival Brazilian payment stock PagSeguro Digital. Another competitor, MercadoLibre, an Argentina-based e-commerce giant across much of Latin America, recently reported much better-than-expected earnings.

StoneCo is already profitable, and earnings are accelerating. Over the past three quarters StoneCo earnings have been increasing at an average rate of 500%, including a 700% EPS gain in the latest period. Sales are strong, increasing at a 67% rate over the past three years, and 75% in the latest quarter.

While it serves merchants, StoneCo also sells its solutions to integrated partners such as payment service providers. One selling point is the firm has developed a distribution solution. It has hubs near customers that include an integrated team of sales, service, and operations support staff.

There are risks to the stock. JPMorgan analyst Domingos Falavina rates StoneCo as neutral with a 22 target, and warned it faces competitive threats.

“We see STNE as fairly priced at current levels,” Falavina said in a research note last month.

“We see risks to the investment case related to more aggressive pricing strategy from incumbents, particularly given Stone’s significant overlap in the SME market and current cheaper prices vs. incumbents in our view.”

He also said the firm has higher dependence on prepayment revenue compared to incumbents.

However, he said there are upside opportunities for the stock too, such as customer stickiness due to software usage; and multiple convergence to peers such as Square stock or PayPal stock, which trade at significant premiums.

The stock recently pushed above its IPO price.

STNE daily chart

The breakout is also clear on the weekly chart. The pull back after the IPO is a common pattern and the break out that eventually pushed the stock above that price is sometimes considered to be a buy signal.

This pattern could be instructive for traders considering whether or not to buy Lyft and other large IPOs expected to come to market in the coming months. It could be best to wait for a pull back and rally.

Trading the Trend

When a stock is expected to move higher, traders could consider obtaining long exposure to the stock to profit. A number of options strategies could be used to meet this objective.

Among those strategies is a bull put spread that could be used. The risk and reward diagram is shown below and it offers limited risk with limited potential gains. However, it is well suited for a stock which is in an up-trend.

bull put spread

Source: The Options Industry Council

This strategy involves two put options. One put option is bought and a second put option with the same expiration date but with a lower exercise price is sold. Selling the put option will generate immediate income, just like the more familiar covered call strategy would. But, unlike a covered call, risk is limited.

Many traders will be familiar with the idea of a covered call. This is a conservative strategy many long-term investors use to generate income in stocks they own that are unlikely to make large moves.

Although the bull put spread is different than a covered call, the bull put spread strategy meets the same objective as the covered call which is to generate some income. This trade generates immediate income and carries limited risk.

A Specific Trade for STNE

 Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.

When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.

For STNE, a bull put spread could be opened with the April 18 put options. This trade can be opened by selling the April 18 $27.50 put option for about $1.40 and buying the April 18 $32.50 put for about $3.80.

This trade would result in a credit of $2.40, or $240 per contract since each contract covers 100 shares. That amount is also the maximum potential gain of the trade.

The maximum possible risk is the difference between the exercise prices of the two options less the premium received. For this trade, the difference between exercise prices is $5 ($32.50 – $27.50). This is multiplied by 100 since each contract covers 100 shares.

Subtracting the premium from that difference means, in dollar terms, the total risk on the trade is then $260 ($500 – $240).

The potential gain is about 92% of the amount of capital risked. This trade will be open for a relatively short amount of time and the annualized rate of return provides a significant gain.

The bull put spread is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that could be lower than owning the stock. This strategy also has a high probability of success.

For more information on options click here for our free guide, The Ultimate Guide to Options Trading.