Here's an Option That Never Goes Out of Style

Low-priced stocks like Cato often offer huge upside with limited risk. That's especially true for debt-free firms like CATO, which sport long histories of profitability and generous dividend payments. Covid-related factors robbed CATO of its fiscal 2020 profits, though, and led to a temporary suspension of dividend payments. That led to an incredible buying opportunity for those who realize that both those things will likely be reversed before long. CATO was solidly profitable year-after-year during the entire period 2004 through 2019. Since 2010, it averaged about 15-times earnings while paying around 4.77% in current yield. Throw out this year's results due to retail shutdowns from March through June and look ahead to fiscal 2021, which ends Jan. 31, 2022. Value Line sees earnings per share bouncing back to $1.50, putting CATO, at its Tuesday quote of $6.64, at a forward multiple of just 4.4-times. At its to-the-penny low in March of 2009, CATO fetched $12.80 when earnings per share were destined to come in at a similar $1.55. CATO changed hands for at least $18, and as high as $44.90 during each of the most recent dozen years, including 2020 year-to-date. There's no reason to think it can't recover those previous peaks within the next year or two. Even 14-times next year's estimate suggests $21 is possible by Jan. 31, 2022. CATO is 100% debt-free. It has no pension liabilities and no preferred shares. Management has been very shareholder friendly over the years via generous dividend payments. Quarterly distributions could be resumed before too much longer. Value Line's analyst sees payments of 75 cents per share as likely in 2021. That rate would deliver 11.3% based on the current share price. Independent research house Morningstar calls CATO's present-day, as opposed to year-ahead, fair value as $9.80 per share. Simply reverting to that very modest level would provide about 47% upside. Despite the 2020 set-back CATO's book value is expected to be $10.85 per share when fiscal 2020 wraps up in January. Longer-term prospects appear incredible. Value Line thinks $25 - $35 is on tap not later than 2025 as EPS rebound to $1.85. That might even prove too conservative. CATO earned $2.11 to $2.39 four times since 2011. With so much potential upside, owning CATO shares outright is my preferred play. At less than seven bucks a share you can think about the stock more like a perpetual call option on CATO's eventual recovery. Option-minded players might wish to consider setting up buy/write combinations out to April 16, 2021 using $5 or $7.50 strike prices. Actual pricing for those options, with CATO at $6.64, is shown below. Here are how those two different strike prices compare on risk/reward characteristics. If executed in a margin account with adequate free buying power to secure the puts the money received for the option sales can be used to help pay for the shares being purchased. For simplicity, I've used 1,000-share, 10-contract sizing in these examples. If held through expiration day the following best-case scenario would play out if CATO merely holds at $5 or above. Amazingly, you'd net 25.7% in under six months if the stock goes up, remains unchanged, or even if it declines by no more than 24.7% from its trade inception price. How cool is that? What if CATO does sink to under $5? Barring a true tragedy, even that result appears far from scary. You'd end up with a double-sized position at an average net cost of just $4.49. Any drop of less than 32.3% would allow for immediate liquidation for at least a small profit. Future stock market action can never be guaranteed. That said, owning CATO at that $4.49 break-even price would have been a winning positon 100% of the time dating back more than 12 full years. Executing this $5 buy/write provides a 32.3% margin of safety combined with the chance to make up to 52.7% annualized on a stock that doesn't even need to go up. If, like me, you're more bullish CATO than average, the $7.50 strike priced buy/write offers a bit less downside protection accompanied by the chance at much higher upside. If CATO manages to rise, and hold, at $7.50 or higher on expiration day the following best-case scenario will unfold. Any move of 13% or better would deliver a cash-on-cash return of 70.8% in under six months. If CATO fails to reach $7.50 by then you'll end up with a double-sized position, but at a very attractive price point. CATO hasn't changed hands as low as $5.95 in more than 13 years. There has been no insider trading in CATO since January 2019. From August 2015 through January 2019, there were an even dozen insider buys vs. zero sales. Prices paid were well above today's quote. What more can I say about CATO? Buy some shares, sell some puts, or consider setting up buy/write combinations. Those with reasonable time horizons should end up doing very, very well.

Here's an Option That Never Goes Out of Style

I've got two ways to play Cato Corp. -- a retailer that sports a long history of profitability and generous dividend payments.

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