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A bear market investment strategy using Las Vegas Sands

TAGs: Editorial, Las Vegas Sands

Is ongoing stock market volatility making you dizzy and confused? Congratulations. You’re completely normal. We have a long way to go before this is over, and the worst is still ahead of us. These conditions make it very difficult if not impossible for passive investors to find something to tuck away and ignore without actively managing the position on a day-to-day basis. What I’d like to present here is a strategy using only one stock that has a buy-and-hold component with hedges. One part of it will have to be actively managed until market volatility dissipates, which could take a year or more. More conservative investors can ignore the hedge component.

A bear market investment strategy using Las Vegas SandsThe company we will use for this strategy is Las Vegas Sands. This stock has the advantages of both an extremely volatile, and extremely stable company. That seems like an internal contradiction but bear with me (no pun intended). From a technical standpoint, LVS is one of the most volatile gaming stocks available. One could argue that Wynn and Galaxy have higher volatility, and by certain measures that’s true. However, neither of those casinos dropped over 99% during the 2008 financial crisis, and LVS has more stable fundamentals than either plus a generous dividend that is not in danger of being cut.

Before we get into the actual strategy, here’s the argument. If we look back at the LVS collapse from 2007 to 2008 and cross-reference it with the company’s actual financial condition, we find a complete disconnect. Usually, when a company falls over 99% from top to bottom, we’re talking about serious and imminent bankruptcy issues. Completely unmanageable debt loads, liquidations of entire swaths of the business, a very slim possibility of recovery, a war between equity holders and corporate bond holders over who will get the remaining assets, that sort of thing. We saw this with Caesars for example. We’re seeing it with General Electric now. We saw it with Fannie Mae and Freddie Mac in 2008. These are examples of near total collapse where a 99% plus decline in shares would be appropriate. But with LVS, look at what was going on in 2008. The company was in no serious danger. It was hurting, but it was never going out of business. It was actually growing in many respects.

From 2007 to 2008, top line revenue grew by 53%, and this despite very tough economic conditions. From 2008 to the end of 2009, top line grew again by 4%, which showed that the growth was sustained. True, operating income fell from $330M in 2007 to a loss of $28.7M at the end of 2009 and net losses for 2009 were $540M compared to a $117M profit in 2007, but when top line is growing, a loss of even half a billion is hardly a threat of bankruptcy. What was causing the losses was mainly balance sheet impairment and debt service. Impairment is a one-time write-down and whether interest expense becomes a systemic problem or not depends on a company’s debt structure. LVS never had any serious structural debt issues even though its interest expense was quite high in 2009.

Now, just because LVS is a good pick for buy and hold does not mean that it won’t collapse. I expect it will, but by how much I don’t know. I don’t think the collapse to be as bad as it was in 2008, but shares will probably fall significantly from here. However, if and when they do, they will eventually climb back up to where they are now because the company is fundamentally healthy and I don’t see that changing. If it could survive 2008 without any existential danger, it can survive what’s ahead.

If there’s a collapse ahead, how are you supposed to buy? This is a combined strategy of scaling in and hedging with puts. Those who don’t trade options can limit the strategy to simply scaling in, on the assumption that dividends will not be cut, or if they are, that they won’t be cut significantly. If you don’t think that’s the case then don’t follow this method. Just keep in mind LVS is not in a General Electric-type situation where a giant is drowning in hundreds of billions in debt and keeps a nominal dividend just for the sake of saying it pays dividends. LVS has less than $10B in borrowings on its balance sheet and it has been paying dividends since 2008 when preferred stock dividends were first listed on its income statement. If 2008-2009 didn’t stop dividends or even cut them, the next collapse probably won’t disrupt distributions to shareholders either.

So let’s say you want to build a $50,000 position in LVS over the next year. The current yield is 5.5%. Let’s assume the next decline really hammers shares and we hit a low of $15 by this time next year. I’m not predicting that, but rather just using it as an illustration of where a long term strategy like this could lead assuming constant dividends and dividend reinvestment. So we have a little over $4,000 a month for scaling in. If we reach a low of $15 by November of 2019, that would be an average stock price of $34 if you buy the dips at $4,000 a month for an average yield of about 9%, rounding up from 8.8% by taking into account dividend reinvestment along the way out 1 year. You’d be down nominally about 16% at the lows, but even if LVS stayed at its lows for another 2 years, you’d be back at break even by late 2020 and collecting income from there. If shares went a little lower, say $10, then it would take another year to 18 months to recover, not too big a deal if you’re not retiring imminently. By that time the decline should be over and you’ll have a bunch of LVS shares at a 9% or more average dividend locked in.

This is the conservative approach and should take about 2 to 2.5 years to materialize, but all you have to do is divide your desired position by 12 and keep adding each month as the price keeps falling. Of course if LVS bottoms early or has already bottomed (unlikely but anything’s possible) you can just sit on your gains and collect dividends without adding anything and move on to the next investment idea.

If you want to hedge with options, then you can follow the strategy above and add put option hedges as follows. Say you have $50,000 again. You could scale in over 12 months with $45,000 of that capital in the same way. Just buy once a month on a strong down day every month for the next year. With the remaining $5,000 in capital, you can buy puts going out to January 2020 on strong up days at a strike near the price of where shares were at their lows of the day on that up day.

Let’s take yesterday, November 26, as an example. LVS finished the day up 7.3%, in a range between $51.92 and $54.67. The next day at the open, you start scaling in with your first tranche and also buy $2,500 worth of January 2020 $52 puts, around the lows of the previous day. That will protect your downside for that tranche. If shares don’t go back down to $50 then you keep your gains but lose the capital you hedged with for a wash or manageable nominal loss, and move on to the next trade. If they go back down to $50, you close the puts when you’ve recouped your losses on the first tranche and buy another tranche of shares right after you sell the puts. On the next strong up day, buy another $2,500 or so at a strike around the lows of that up day and do the same thing again.

The difference here is you’re protecting your downside as you scale in, and if you end up losing $2,500 in put option protection at any tranche, then that means, de facto, that LVS has bottomed and you can keep your shares and your gains. Eventually dividends and reinvestment will recoup those hedging losses.

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