CDW Corp.: Using Market Maker Hedging-Derived Price Forecasts (NASDAQ:CDW)

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Investing Thesis

We will illustrate with a high (not top) ranked stock

CDW Corporation (NASDAQ:CDW) – previously AKA Computer Discount Warehouse – will be used as an example subject here. It is used because it ranks high on many parts of the information resulting from our behavioral analysis of the self-protective actions of volume Market-Makers, as they help big-money investment manager clients adjust billion-dollar portfolio holdings.

Figure 1

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The ordinary fundamental analysis seen in Figure 1, plus manifold additional information, is subsumed in the value decisions of the market-makers [MMs] as they “facilitate” multi-million-dollar transactions in CDW initiated by their clients. The facilitations involve putting MM firm capital temporarily at risk to balance buyers with sellers so that the holdings adjustment desired by the client can be accomplished in one “block” trade, at a single price, at one point in time (usually as immediately as possible).

MMs maintain extensive worldwide 24×7 information-gathering systems, well-staffed with experienced analysts and observers, continually communicating with the MM’s traders.

Hedging transactions in derivatives markets provide the MMs with protection against unwanted price changes until their exposure can be traded off in “regular way” transactions on the exchange.

What must be paid for that protection is negotiated between buyers and sellers of the derivatives, so both bull and bear perspectives for the underlier are represented as likely possible/probable upside and downside price limits seen at that point in time. As events ensue, the limits migrate to reflect changes in perceptions, and changes in the “order flow” of the players in the game having the money muscle to move prices.

Figure 2 shows in its daily vertical lines how those implied forecasts have trended for CDW over the past 6 months. The heavy dot in each is the closing market price on the day of the forecast.

Figure 2

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(used with permission)

There is helpful data downstream from the implied price limit forecasts

Each forecast is specific to perceptions about the stock at the time.

So what happens subsequent to each forecast forms an actuarial record that can be useful in making comparisons with the subject’s past, and in making comparisons with other investment candidates’ own similar characteristics.

The row of data in Figure 2 between the two blue pictures contains much of the useful information.

The first three items are the forecast range limits and the closing price they relate to. The next item is the upside percentage price change seen possible/probable between the forecast range high and the current price. The rest of the data items have particular connections to the Range Index item.

The Range Index measures what proportion of the whole (high to low) forecast range lies below the current price.

Here that amount is 1: {(169.34-169.14)/(186.78-169.14)} x 100

RIs are sort of a “price-tag” on the expectations for a stock’s coming prices. A low RI offers relatively large upside prospects, and a high (above 50) warns of more downside than upside. CDW’s current 1 is low in comparison to the general forecast population, which at this point averages 23.

The market-proxy ETF of SPDR S&P 500 Index (SPY) is at 24, below its historic average and modal (most frequent) point of 35.

But when thinking about specific securities’ prospects, it is important to reflect on a stock’s own RI in comparison with its history of several recent past years. That is because, as stock groups develop different P/E norms, so do stocks develop their own RI characteristics. So we provide the small blue thumbnail picture of each stock’s past 5-year frequency of RIs.

Here CDW demonstrates a wide array of prospect evaluations.

In contrast, stocks with little controversy or price dynamism tend to have RIs that cluster, sometimes rather tightly, around a norm. WMT, T, and SPY come to mind, among others. MM price range expectations information offers more frequent opportunities for timely selections in stocks like CDW.

But on occasion, the appearance of a RI well out of a stock’s usual distribution can be an important warning.

In general RIs to the left (cheaper) side of a stock’s RI distribution tend to be attractive, while those to the right may be a caution of coming price weakness.

For this general reason, we look to the actual market price experiences subsequent to the prior appearances of RIs which were like that of the current forecast. For them to be reasonably reliable there must be enough of them to offer statistical significance. We arbitrarily choose 20 priors as a threshold, so in that row of data between the two blue pictures of Figure 2, if the current RI has fewer than 20 priors in the past 5 years (out of 1261 market days) we flag the section in red as a caution.

Other data items in the row are based on the prior RI sample.

The price drawdowns are an average of the prior RI sample experiences’ worst cases. The Win Odds tell what proportions of the sample recover from those drawdowns to reach their sell targets, or at least be above their entry cost price when they run out of holding period time under the 3-month TERMD limit.

Days held is a count of the average number of market days that the sample prior RI positions were required to be held under TERMD. Annual rate of return is the CAGR of all prior RI sample position %Payoffs, including the losses.

The Cred.

Ratio is a credibility measure of the upside prospect potential of the current day’s forecast. It pits the % reach for the Sell Target against the %Payoffs actually reached by like prior RIs of the sample.

The essence of valuation is comparison

Once the price prospects of an investment candidate are understood, a productive capital commitment contest needs their comparison with other eligible competitors. Investment policy issues may also urge consideration of the overall market condition.

To that end, we usually provide the following Figure 3 review in our Seeking Alpha articles and as a regular part of our top20 Market-Maker Intelligence Lists:

Figure 3

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(used with permission)

Two items of data in Figure 3 are not present in Figure 2. They are the [T] Reward-Risk Ratio and an [R] overall measure Figure of Merit [FOM] used to rank the subject stocks’ attractiveness to a presumed investor in search of wealth-building opportunity. (14) Uses the elements in [D] and [E]. [Q] Weights the [D] and [E] elements using [H] and its complement [H-100]. [R] uses [J] to determine FOM’s rate of holding period change.

CDW is not now in the 20 Best issues of today’s MM Intelligence List, partly because of slightly smaller upside prospects [E] and less frequent opportunity [L] despite its superior Win Odds [H]. You may put different levels of importance to some of those dimensions than did the ranking process.

The great advantage of this manner of attractiveness comparison is that the use of price range forecasts as the base of expectations puts everything in terms of coming prices which are directly comparable between stocks of all varieties.

The relationship of today’s expectations to similar prior expectations of the same company then makes comparisons of those qualitative dimensions relevant on a direct basis between companies.

Having the secondary qualitative dimensions (of odds for profit, price drawdowns, forecast credibility, and basis points per day of capital gains) accessible to be contemplated allows each investor to flexibly limit or weight each to suit his/her specific preferences.

After all, it is the investor who lives with the outcomes.

Conclusion

Using today’s relevant data does place CDW Corporation as a buy well ahead of most typically contemplated portfolio components given its current comparisons with the ODDS of profitable outcomes and reward-risk tradeoffs.

For those not intent on seeking nirvana, the [R] FOM does a quite passable job of providing quick discriminations between eligible alternative investments for the wealth-building investor willing to shuck off the many misguidances of last century’s fixation with the buy & hold strategy and adopt the active investment strategy offered by TERMD.