At the end of February, I made the case for a looming market correction based on slowing economic data, downward revisions in corporate earnings growth and the S&P 500’s high price-to-earnings (P/E) ratio.
Over the following two weeks, the S&P 500 dropped more than 3% before trading back up and hitting new all-time highs. But I don’t think we’re in the clear yet.
During the first quarter, the companies of the S&P 500 delivered another lackluster performance, with net earnings rising a paltry 2.4% year over year while revenue contracted 3.7%. Take out financial stocks and total earnings growth would have actually contracted 1.2% year over year.
And it doesn’t look like things are getting better.
What concerns me even more is that markets have moved higher while earnings growth is basically flat and future earnings estimates are dropping. This has caused the S&P 500’s forward P/E to increase from 17.62 in February to 18.02 today. That’s the highest reading in almost 10 years and 18% above the 10-year average of 14.88.
Now, I’m not forecasting the next recession, but rather a reset (correction) of more than 10% over the course of a few weeks, which we haven’t had since late 2011.
That’s why I’ve been betting against the most vulnerable stocks in the market lately using put options.
In late February, we bought put options on Keurig Green Mountain (NASDAQ: GMCR) and generated a 34% profit in less than two months when shares fell 11%. A month later, we bought puts on Yelp (NYSE: YELP) and closed that trade in less than a month for a 40% gain on a 13% drop in the stock.
As you can see, buying put options is an easy way to amplify your gains when the price of the underlying security drops. And given current market valuations and earnings trends, I think they’ll be the best way to make money in the coming months.
That’s why I recommended a new put trade last week to my Profit Amplifier readers. Like GMCR and YELP, the stock I’m betting against is expensive and is seeing slower sales and earnings growth.
Hain Celestial Group (NASDAQ: HAIN) is a leading natural products company that manufactures all sorts of organic and natural foods, from cereals and pastas to yogurt, tortilla chips and more. The company boasts dozens of brands that can be found mostly in specialty stores like Whole Foods Market (NASDAQ: WFM), Sprouts Farmers Market (NASDAQ: SFM) and Trader Joe’s, but have also made their way into the traditional supermarkets like Kroger (NYSE:KR), Albertsons, Tom Thumb and others.
Hain Celestial delivered double-digit year-over-year sales growth over the past 18 quarters, but that trend is changing. On May 6, the company reported third-quarter sales of $662.7 million, an 18.9% increase over sales from Q3 2014. While seemingly strong, that’s a sharp deceleration from 32.2% year-over-year growth in Q1 and 31.2% year-over-year growth in Q2.
Earnings growth has also decelerated in each of the past four years, dropping from 82.9% in 2011 to 26.2% in 2014. Based on analyst expectations, that trend will continue, with growth slowing to 18.2% in 2015, 16% in 2016 and 12.4% in 2017. Despite the slowdown in growth, HAIN has risen 52% since its August low.
At current prices, the stock has a forward P/E ratio close to 30 and a PEG ratio of 3.1. The PEG ratio is simply the P/E ratio divided by the expected annual earnings growth rate, and 1 is considered to be fair value. These metrics make the stock look extremely expensive for a company with slowing growth expectations.
For comparison, HAIN’s forward P/E is 41% more expensive than its peers in North America and more than 65% pricier than the S&P 500. Its PEG ratio is triple what most consider fair value and what I look for in a long trade. In fact, many analysts often target stocks with ultra-high PEG ratios as potential shorts since share prices are simply not supported by earnings growth.
Perhaps HAIN’s valuations could be justified if the company was blowing away analysts’ estimates, but that’s not the case. Its most recent earnings were just in line with expectations.
Furthermore, I don’t think the intense competition in the space is being accounted for in future earnings estimates. Analysts note that the company faces “dozens, if not hundreds of [competitors].” Everyone from old standbys like General Mills (NYSE: GIS) and Campbell Soup (NYSE: CPB) to up-and-comers like WhiteWave Foods (NYSE: WWAV) are vying for space on the shelves. And all are taking potential market share away from HAIN.
Even supermarkets like Kroger, Wal-Mart (NYSE: WMT) and Whole Foods are producing their own organic foods and products priced more aggressively and promoted more vigorously in store than brands from outside vendors like Hain.
I believe HAIN will get a haircut over the next 3-5 months and its astronomical valuations should come back down to Earth. I expect shares to fall to their 200-day moving average at $55.70.
Using options, we can amplify HAIN’s potential 10% move lower into a 102% gain. Specifically, I recommend buying HAIN Aug 65 Puts for $4.60 or less ($460 per contract, which controls 100 shares).
This trade breaks even if shares fall to $60.40 ($65 strike price minus $4.60 premium), 3% below current prices.
If HAIN hits my $55.70 price target before expiration on Aug. 21, the put options will be worth at least $9.30 ($65 strike price minus $55.70 stock target). Place a good ’til cancelled (GTC) limit order to sell your puts at that price. If the 20-day moving average crosses back above the 50-day for two days, exit this trade.
So, for less than $500 per contract, we risk less and could make more than 10 times the return of someone shorting the stock. In fact, since we’d earn 102% in just 88 days, that works out to an annualized return of 423%.
Since I launched my Profit Amplifier service three months ago, we have already closed trades with annualized returns of 221%, 509% and 2,202%. If you want to learn more about my method or get trades like this sent directly to you each week, follow this link.
