Lender Processing Services, Inc.(LPS) had trailing twelve month(ttm) per share earnings for 2Q 2010 to 2Q 2011 at $2.50 a share. Dividing $2.50 by the pre-tax corporate A bond yield for 28 Oct. 2011, approximately 5.23%, you get a relative value of $47.80 a share.
For 2011 year-to-date you could have bought a share of LPS for as low as $12.91 and as high as $34.88. Since ttm per share earnings were $2.50, paying between $12.91 and $34.88 a share your initial rate of return would be between 7.16% and 19.36%. At today’s price of 17.73 you get an initial rate of return of 14.10%
A review of LPS’s per share earnings growth rate for the past three years indicates that it has been growing at an annual compounding rate of 6%. So you can ask yourself: What would I rather own - government or corporate bonds with a static interest yield of 2.32% or 3.40%, respectively, versus a LPS equity/bond with an initial earning/interest yield of 14.16% that increase at an annual rate of 6%?
Utilizing Kelly Criterion for this initial analysis, I find an initial allocation of 3.55% to be appropriate with a full Kelly allocation of 21.32%. With an upside profit differential of 30.07 and a downside permanent capital loss differential of $9.72, my risk/reward profile stands at 3.09 to 1. The downside is based on $5.51 book value plus an estimated $2.50 for next year’s earnings which I would presume not to be at risk for based on the company’s business model. I hold an initial confidence level of 90% based on LPS falling in tier 1 grouping of my list and find that my ability to pick stocks that outperform the market to be correct roughly 45% of the time.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.
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