Shedding Some Light on a Great Buy

Major indexes hit new record highs on Friday. By definition, many big-name stocks are pretty expensive right now. Rather than chasing what has already gone higher, consider taking a stake in a fine company which is still cheap. Lighting equipment manufacturer Acuity Brands is completing a very fine decade. From fiscal 2010 through fiscal 2020 -- which ends Aug. 31 -- AYI grew all major business metrics significantly. If this year's estimate proves accurate, its earnings per share, or EPS, will have expanded by almost 400%. Continuous shareholders have nothing to complain about. Total return over exactly 10 years through Friday was 291.8%. Dig a bit deeper, however, and you'll see that AYI carved out an all-time high near $281 in August of 2016. Overenthusiastic momentum chasers at that high point were paying 36.4-times trailing earnings to own Acuity. Since then, it sold off gradually, bottoming on Christmas Eve 2018 at just $103.50. At that time AYI was available for just 11.7-times trailing EPS. AYI hadn't been that cheap since the very dark days of the 2008 to 2009 crash. Traders who bought near that nadir had the chance to sell north of $147 just four to five months later. As of Friday AYI still traded for a very reasonable 13.3-times multiple compared with its 10-year average price-to-earnings of 22.3-times. This fine growth stock saw its multiple compress despite year after year of record profits. Just a partial recovery towards a more normal valuation could easily send AYI shares back up to $180 to $190 by the end of next summer. That goal appears very attainable. AYI topped out between $187 and $281 during each of the four years from 2015 through 2018. Fundamentals are better now across the board. Acuity's four should have sold moments (red-starred above) saw traders paying from 21-times to 36-times. When sentiment heats up again, AYI might surge back toward $200 to $300 on the growing EPS expected over the coming years. I own a large chunk of AYI shares at an average cost just shy of $117. I've written well out-of-the-money covered calls three times already since buying the stock. All those options ended up expiring worthless, allowing me to keep my position intact while also keeping the money from the premiums received. Now, I'm thinking about selling some new ones out to Dec. 18, 2020 at strikes ranging from $180 to $190. Actual bid-ask prices, with the shares at $136.48, are shown below. Why would I be willing to cap my upside if I'm bullish on AYI? Writing only strike prices way above the current price would leave me plenty of upside while providing me with from $4 to $5.60 per share of downside protection. On every 1,000 shares held, that translates into immediate income of from $4,000 to $5,600. If AYI goes up as I expect I would still pocket the first 36% to 42% of the move plus any dividends earned along the way. If it goes even higher, as is certainly possible, I'll probably have the chance to roll the calls up and out to a later expiration date and a higher strike price. Traders looking to play AYI without actually buying shares right now can consider selling some Dec. 18, 2020 expiration date put options. You could have collected almost $20 per share for committing to buy at $140, if exercised. Your net exercise price would drop to $120.10. The more aggressive $150 puts were paying $25.50 per share. Worst-case, forced purchase would thus take place at $124.50, if exercised later. If you like AYI at $136.48, it's hard to picture why you would be hesitant to own it from 8.7% to 12% cheaper. When I bought my shares previously, I also sold some Dec. 18, 2020 expiration date puts at $130 and $140 strikes. Break-evens on those trades were $111.70 and $114.39 respectively as AYI, on the trade inception date, was a bit lower then than it is now. I often short both covered calls and naked puts on stocks I own. It brings in lots of money up front, reducing the risk on the shares I'm already long. Both option buyers can end up being wrong. On expiration day, though, it's guaranteed that no more than one could be right. If AYI closes above $180 on expiration day, it is certainly not under $130 or $140. If AYI is south of the put strikes it can't also be north of the call strikes. Here's a quick cheat-sheet to easily understand the possible outcomes from owning AYI at my average cost while shorting the $180 calls as well as the $140 puts. The best-case scenario would occur if AYI reaches at least $180 on expiration day. A profit of $9,462 on a net cash outlay of $8,577 translates to greater than 110%. What if AYI merely marks time from now until next December? That static movement would still generate an excellent gain due to the income received from selling both the call and put. Seeing $4,758 on $8,577 equals an 80.9% cash-on-cash return. It's sensational on a stock that went nowhere. Even though I'm very bullish, AYI might decline in price over the coming year. AYI could drop to no lower than $112.70 though the Dec. 18, 2020, expiration day without causing a loss. Any smaller decline would still provide at least a small profit. What are the chances that AYI falls even further, causing true damage? History says that risk is very small. Acuity traded above $112.69 more than 99% of the time dating back more than a full half-decade. Even more importantly, EPS surged from $5.40 to $9.57 while the price declined. Fiscal 2020 estimates for the year ending Aug. 31, 2020 now center on $10.30.

Shedding Some Light on a Great Buy

The opportunity left in high-priced, big-name stocks may be dimming, but Acuity Brands looks ready to shine.

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