Cboe: A Test Case in Discovering the Cost of Over-Enthusiasm

Even the best companies can have stocks that get way too expensive. With proven growth firms, if you're willing to wait long enough, you'll probably end up making some money. Imagine, though, how much better you could do if you were able to recognize overvaluation and trade out before major pullbacks. You could then sidestep those declines, while redeploying your money into other stocks. When the original shares became cheap again, you could then repurchase at favorable prices, and start the cycle all over again. This technique is especially useful in non-taxable, or tax sheltered vehicles like IRAs, or 401(k) accounts. Let's use the history of Cboe Global Markets Inc. as a true-life example. CBOE came public in June 2010. It's had a stellar record since, growing earnings per share from $1.03 to an expected $4.13 for 2019. Dividends have grown significantly as well, rising from an annual rate of 40 cents to $1.24. Continuous shareholders, who never sold at all, did just fine. The fervor following the initial public offering took CBOE to over $34. As of July 5, the stock sat at $110.40. That big picture obscures lots of very relevant facts, though. Early buyers near $34 took an almost immediate, 2-month hit to below $20. Holders who failed to get out near CBOE's March 2014 peak suffered almost 29% draw-downs. It wasn't pretty going from $72.50 to $58.40 from November 2015 through February 2016. More recently, momentum chasers who piled into CBOE north of $138 in January of 2018 are were nursing greater than 36% declines at CBOE's low, eleven months later. As of July 5, 2019, they were still down by over $28 per share a full 18-months after buying. How could they have avoided paying too much, or pulled the trigger on sell decisions at the right times? They needed to understand CBOE's prior trading history. Since 2010, CBOE's average price-to-earnings ran about 23.5-times. A typical yield was around 1.57%. All four of the stock's should have sold moments (red-starred below) occurred when CBOE's valuation was well in excess of those normalized levels. The price-to-earnings were too high and the current yields were subpar. Conversely, five of the six best buying opportunities (green-starred) for CBOE launched their rallies from cheaper than typical P/Es. That same proportion of good entry points offered better than average yields as well. Buying too high, or failing to sell, when over enthusiasm was evident in CBOE's valuation caused pain, when the shares declined sharply. Another hidden cost was the time wasted waiting for the stock to simply regain its old peak. The table below shows how many months passed from high points when investors could still have bought back at exactly the same price. Sitting with shares from 13 to 32 months, just getting even tries the patience of even the staunchest believers in a company. It remains to be determined how long it will take CBOE to regain its old January 2018 pinnacle. After a year and a half it, remains well below breakeven for those who bought at the top. What is CBOE really worth? Applying a normalized 23.5-times multiple on this year's estimate suggests a year-end 2019 price of about $97.52 would be appropriate. By Dec. 31, 2020, if all goes well, CBOE could rise to $111-$112. Those very realistic goals imply unexciting near-term returns from today's quote. Independent research firm Morningstar seconds my logic. They assign CBOE a rarely seen 1-star, out of 5, Strong SELL rating. Morningstar sees CBOE's present day fair value as just $92.27. Those who feel they just have to play CBOE might do better selling long-term puts with near-the-money strike prices rather than buying shares outright. Worst case, forced purchase prices dipped to from $99.20 to $103.90 with the shares fetching $110.40. The 18-month time horizon until expiration should allow future growth to add to CBOE's true value. Sellers of the puts would get a discount to the current price, while committing to shares which would likely be more valuable than they are today. Knowing a company's 'proper price' is the key to good decision making. Those who understand that have the best chance to make stock market gains. Those who don't live by this principle are usually doomed to failure and frustration.

Cboe: A Test Case in Discovering the Cost of Over-Enthusiasm

Let's use the history of Cboe Global Markets Inc. as an example of how to recognize overvaluation and trade out before major pullbacks, potentially side-stepping declines.

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