Stocks to Watch for the Week of February 11, 2013

Michael Fowlkes, InvestorsObserver

Dell announces $24.4 billion leveraged buyout

What's happening with DELL: Dell (DELL) stock has gained nearly 50% since its founder, Michael Dell, announced he was working on plans to take the company private in October. The weakening PC market has taken its toll on Dell and by going private, the company plans to remove itself from the scrutiny of Wall Street, which will allow it to focus on the long-term. The leveraged buyout is worth $24.4 billion, which, if approved by the company's board of directors, would equate to $13.65 per share, just above with the stock's current price around $13.50. Current pricing should reflect the risk of the deal falling through. Since there is little spread between the offer and the stock's price, that indicates the market thinks approval is likely.

Technical analysis: DELL was recently trading at $13.52, down $4.84 from its 12-month high and $4.83 above its 12-month low. Technical indicators for DELL are bullish and the stock is in a strong upward trend. The stock has support above $13.00. Of the 34 analysts who cover the stock six rate it a "strong buy", seven rate it a "buy", 19 rate it a "hold", one rates it an "underperform", and one rates it a "sell". The stock receives Standard and Poor's 3 STARS "Hold" ranking.

Analysts' thoughts: While going private is most likely a good option for Dell, there is concern that the company's major shareholders will not approve the deal. The two biggest complaints that have surfaced are a lack of specifics about the deal and a possible conflict of interest with Michael Dell being the biggest shareholder, still holding around 16% of the company. I believe in the end the deal will get approval, and Dell will manage to take the company he founded private. Going private will help the company move away from its heavy reliance on the PC market, but with Microsoft (MSFT) contributing $2 billion to the deal, we should expect that influence to cause Dell to stick with the PC market.

Stock-only trade: With the stock getting ready to go private, we would not suggest setting up a stock-only trade at this time. The stock is trading just shy of its buyout price, so there really is no premium to make by setting up a stock position at this time.

Bullish option trade for deal approval: If you believe that the board of directors will approve the buyout in its current terms, you can set up an August 8/13 bull-put spread for a credit of 20 cents. That's a potential 4.7% return (7.4% annualized*) and the stock would have to fall 2.4% to cause a problem. With the negotiation price at $13.65, this is your best play to pull a profit from the deal, since the stock is unlikely to trade much higher between now and going private.

Bearish option trade in case the board rejects the deal: For investors that believe the board of directors will decide not to approve the current deal, then a bearish option trade would make sense. Any news that the board will reject the deal could easily send the stock back down to around the $11 level from early January, so an August 13/18 bear call credit spread would be the way to go. Look at the August 13/18 bear call spread for a credit of 65 cents. This trade has a target return of 14.9% (26.6% annualized) with 1% downside protection. This is a great trade for investors who believe the board will not approve the deal, and it will break-even if the buyout price remains $13.65 and the deal goes through. However, if the price increases, it will end up being a loser.

January retail sales data due February 13

What's happening with GPS: Apparel retailer Gap Inc. (GPS) has been on the rise so far in 2013, after a disappointing second half of the year in 2012. Since the start of the New Year, the stock has managed to trade up slightly over 7%, and is likely to continue its uphill move on strong January sales figures. Gap has already released its January sales numbers, but the market will get a broader picture of the retail sector on February 13 when the U.S. Department of Commerce releases its January retail figures. With consumer spending making up over two-thirds of the nation's economy, all eyes will be on the January retail report. A strong report should help Gap move higher, while disappointing numbers could erode some of its recent gains.

Technical analysis: GPS was recently trading at $33.22, down 4.63 from its 12-month high and 12.07 above its 12-month low. Technical indicators for GPS are bullish and the stock is showing signs of a possible trend reversal. The stock has support above $32.05 and resistance under $35.50. Of the 27 analysts who cover the stock five rate it a "strong buy", six rates it a "buy", 14 rate it a "hold", one rates it an "underperform" and one rates it a "sell". The stock receives Standard and Poor's 3 STARS "Accumulate" ranking.

Analysts' thoughts: We believe that the January retail figures will not hit Gap too hard, even if they are worse than expected. Gap has already released its own January sales figures, which were impressive. During the month of January the company reported that same store sales were up 8%, doubling the 4% increase that Wall Street had forecast. Several other retailers have also reported strong January sales, so we expect the report from the Department of Commerce to be solid enough to keep Gap from experiencing any selling pressure.

Stock-only trade: If you are looking for a stock-only trade on GPS, consider buying the stock under $32. Put a stop loss on the trade at $28.80 or 10% under your purchase price, and take profits off the table if the stock climbs above $36.80.

Option trade: If you are looking for a hedged options trade on GPS, consider a June 23/28 bull-put credit spread for a 65-cent credit. That's a potential 14.9% return (36.6% annualized*) and the stock would have to fall 10.5% to cause a problem.

Speculative option-only trade: For those of you with an appetite for higher risk and bigger returns, consider buying the September $32 call. If GPS rises just 11.6% you can pull in a 20% or better profit on the option. However, if the stock moves lower, this kind of trade could lose a significant amount.

S&P Credit Agency faces Justice Department lawsuit

What's happening with McGraw-Hill: McGraw-Hill (MHP) is the parent company behind the S&p Credit Reporting Agency, and following the news that the Justice Department was going to pursue a lawsuit against the company the stock took a major hit. Prior to the announcement, MHP stock was trading at $58.50, but quickly took a hit, with sellers driving the price down 24% to it current price of $44.61. The Justice Department is looking for someone to take the fall for the recent financial crisis, and it is taking aim at S&P Credit Agency for the top-notch ratings it gave to toxic mortgage assets.

Technical analysis: MHP was recently trading at $44.61, down 14.01 from its 12-month high and 2.59 above its 12-month low. Technical indicators for MHP are bearish and the stock is showing signs of a possible trend reversal. The stock has support above $43.25. Of the nine analysts who cover the stock two rate it a "strong buy", 5 rate it a "buy", and two rate it a "hold".

Analysts' thoughts: Because of the role that the Standard & Poor's Credit Rating Agency played in the mortgage crisis, it makes it an easy target. While there were plenty of people and agencies to take some blame for the situation, the Justice Department has yet to find anyone accountable, and it is under pressure to do so. With the increasing frustration over the lack of accountability, it is likely that the Justice Department will press hard to make an example out of McGraw-Hill and the Standard & Poor's Credit Rating Agency. Over the last year, McGraw-Hill has net income of $867 million… the Justice Department lawsuit is going to seek $5 billion in damages. McGraw-Hill was offered the chance to settle for $1 billion, but refused. Whether it is $1 billion, or $5 billion, the company does not have the money to pay the fine, and if the penalty does wind up being $5 billion the company will probably not be able to survive, at least in its current form.

Stock-only trade: With the uncertainty surrounding the lawsuit that MHP is facing from the Justice Department we would not suggest setting up a stock-only trade on the stock at the current time. We will revisit the situation when more details on the lawsuit are made available.

Option trade: If you are looking for a hedged options trade on MHP, consider an May 47.50/50 bear-call credit spread for a 50-cent credit. That's a potential 25% return (80% annualized*) and the stock would have to rise 8.7% to cause a problem. The reason you can pull such a big return on this trade is that the stock has sold off so sharply over the last week, but with the pending lawsuit we believe that we could see additional downside in the stock.

Speculative option-only trade: We do not want to set up a speculative option-only trade on MHP at the current time. With the recent selling pressure we have seen, the puts are not priced in a way to make a bearish trade worth the risk, and with the pending litigation that the company is facing we would rather not take a bullish speculative trade on the stock either. Option-only trades come with a high level of risk, and the risk is too high considering MHP's current legal situation.

Avon Products (AVP) reports fourth quarter earnings on February 12

What's happening with Avon: Beauty products maker Avon Products (AVP) has been trading higher over the last three months after experiencing selling pressure during the third quarter of 2012. Avon will be reporting its fourth quarter results on February 12, with analysts forecasting earnings of $0.27 per share, down from $0.39 during the same period last year. The company has reported weaker than expected earnings during each of the last six quarters.

Technical analysis: AVP was recently trading at $17.34, down $6.24 from its 12-month high and $3.64 above its 12-month low. Technical indicators for AVP are bullish and the stock is in a strong upward trend. The stock has support above $17.10. Of the 15 analysts who cover the stock two rate it a "strong buy", two rate it a "buy", nine rate it a "hold" and two rate it an "underperform". The stock receives Standard and Poor's 2 STARS "Sell" ranking.

Analysts' thoughts: Avon is in desperate need of a strong earnings report. With the recent run up we have seen in the stock, Wall Street is likely to punish it hard should it fail to live up to expectations for a seventh straight quarter. The stock has definitely been a mess, and it is time for the company's new CEO, Sherilyn McCoy, to show that the changes she has made at Avon are starting to make a difference. She is leading the company through its third restructuring since 2005, and analysts are getting impatient. Avon needs strong numbers, or we are going to see some serious selling pressure on its stock.

Stock-only trade: If you want to set up a stock-only trade on Avon, buy into the stock under $17.25. Place a stop loss on the trade at $15.50, or 10% under your purchase price, and take profits off the table if the stock climbs above $19.00.

Option trade: If you are looking for a hedged options trade on AVP, consider a July 10/15 bull-put credit spread for a 55-cent credit. That's a potential 12.4% return (25.5% annualized*) and the stock would have to fall 10.5% to cause a problem.

Speculative call-only trade: For those of you with an appetite for higher risk and bigger returns, consider buying the August $19 call. If AVP rises just 9.3% you can pull in a 20% or better profit on the option. However, if the stock moves lower, this kind of trade could lose a significant amount.

Goodyear Tire to report fourth quarter earnings on February 12

What's happening with GT: After failing to hit its earnings estimate for its third quarter, Goodyear Tire (GT) hit a little selling pressure in late October, but has since rebounded nicely. Goodyear is scheduled to report its fourth quarter results on February 12, with analysts forecasting earnings of $0.20 per share, up from $0.03 during the same period last year.

Technical analysis: GT was recently trading at $13.59, $1.06 below its 12-month high and 4.35 above its 12-month low. Technical indicators for GT are bearish and the stock is in a weak upward trend. The stock has support above $13.90, and resistance under $13.90. Of the nine analysts who cover the stock three rate it a "strong buy", two rate it a "buy", three rate it a "hold" and one rates it an "underperform". The stock receives Standard and Poor's 4 STARS "Accumulate" ranking.

Analysts' thoughts: Goodyear has a dominant position in the U.S., controlling around 40% of the market. With the auto industry continuing to improve, Goodyear should benefit from increased auto sales. In an effort to lower its operating costs, Goodyear has been expanding its operations in China and Brazil, and recently announced plans to close a plant in France. Another thing that should help Goodyear going forward is that rubber prices are at lows we have not seen since 2009. With rising auto sales, and low rubber costs, Goodyear has a bright future ahead of it.

Stock-only trade: We like the long-term prospects for GT, and would set up a long position in the stock at $13.50. Put a stop loss on the trade at $12.15 or 10% under your purchase price, and take profits off the table if the stock climbs above $15.50.

Option trade: If you are looking for a hedged options trade on GT, consider an April 10/13 bull-put credit spread for a 45-cent credit. That's a potential 17.6% return (74.9% annualized*) and the stock would have to fall 1.4% to cause a problem.

Speculative option-only trade: For those of you with an appetite for higher risk and bigger returns, consider buying the July $14 call. If GT rises just 11.9% you can pull in a 20% or better profit on the option. However, if the stock moves lower, this kind of trade could lose a significant amount.

*Annualized returns provided for comparison purposes only

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At the time of writing, Mr. Fowlkes does not have direct ownership in any of the stocks mentioned.