Objective: Wealth-building of an always fully-invested portfolio via repeated near-term (weeks or months) capital gains from careful, diversified, odds-on issue selection and timely price opportunity capture. This article deals with risk notions by comparisons, with Align Technology (NASDAQ:ALGN) opposing market-price questions currently being raised in the market at large.
What is Align Technology, Inc.’s business?
“Align Technology, Inc., a medical device company, designs, manufactures, and markets Invisalign clear aligners and iTero intraoral scanners and services for orthodontics, and restorative and aesthetic dentistry worldwide. It operates in two segments, Clear Aligner; and Scanners and Services. The Clear Aligner segment consists of comprehensive products, including Invisalign Comprehensive treatment that addresses the orthodontic needs of teenage patients, such as compliance indicators and compensation for tooth eruption; Invisalign Assist treatment, which offers support to dental practitioners throughout the treatment process, including progress tracking; and Invisalign First Phase I and Invisalign First Comprehensive Phase II package for younger patients with early mixed dentition with a mixture of primary/baby and permanent teeth. This segment’s non-comprehensive products comprise Invisalign Express 10, Invisalign Express 5, Express Package, Lite Package, Invisalign Go, and SmileDirectClub; and non-case products include retention products, Invisalign training fees, and sales of ancillary products, such as cleaning material, and adjusting tools used by dental professionals during the course of treatment. The Scanners and Services segment offers restorative software for general practitioner dentists, prosthodontists, periodontists, and oral surgeons; software for orthodontists for digital records storage, orthodontic diagnosis, and for the fabrication of printed models and retainers; computer-aided design/computer-aided manufacturing services and ancillary products, such as disposable sleeves for the wand; and iTero applications and tools. The company was founded in 1997 and is headquartered in San Jose, California.”
Source: Yahoo Finance
Would you force your grade-school daughter to wear a “tin-grin” if, instead she could have a nearly invisible “plastic-mastic”? Such are the decisions from which corporate profits are grown.
The issue of mis-identified risk
Regular readers of our articles know that every market day we evaluate the coming-price-range expectations by the market-making [MM] community for over 2,500 widely-held and actively-traded stocks and ETFs. Their forecasts are derived from the way they seek to protect their firm’s capital while it is necessarily exposed to price-change risks.
The extremes of those forecast price ranges define the MMs’ expected potential coming price volatility for each issue in the near next few months. Conventional investment practice looks to standard deviation of actual prices of stocks over many years of past experiences.
Conventional investing “wisdom” regards that statistical “volatility” as “a proxy for risk” because if it has happened in the past, it could happen again. Carelessly hidden in that assumption is the notion that price-change potential is a static condition across time, one which can be described by an average. The more time considered, the “better” the average.
Having done what we do daily for over two decades (and previously on a weekly basis for a prior 2-3 decades) it is perfectly evident that the propensity for stock prices to change during one period and another is not a static condition. It depends mightily on what knowledgeable observers expect could happen in the issue’s surrounding environment.
But it is far easier to average the past than to project the future. Besides, getting sued over calculation of past facts is much less likely than being sued (or having one’s intellectual image maligned) over assertions of what might happen in the as-yet-defined future. No such risks are taken by academics.
What lies in the future? Uncertainty.
Investment risk lies in the actual loss of capital, not in the worry over what might happen. The calibration of potential risk depends on actual experiences, which have been demonstrated to be quite variable through and across time, not static as an average over great lengths of time.
Being able to anticipate investing risk depends on having a sense of the size of the loss and the likelihood (odds) of its incurrence. By splitting the future uncertainty of price change into upside [Reward] and downside [Risk] proportions on a day by day basis we have the ability to examine what has subsequently happened in actual markets following different proportions of expected reward and risk. Then scores can be kept on size and odds of profitability.
Such scores tell us how well the MM community anticipates coming risks and rewards. Doing that with ALGN has the price range forecasts pictured in Figure 1, and the odds of actual prior gain, loss and net results from only those periods subsequent to prior forecast expectations with up-to-down proportion like today’s.
As a contrast, here is what MM forecasts for the “market-index” ETF of SPDR S&P 500 Trust (SPY) look like at this time:
How effective the MMs have been in forecasting for these stocks is a matter of market records, when conditions of uncertainty similar to today’s are examined. That was done in the row of data between the graphics of Figures 1-2. For ease of comparison, they are repeated and slightly expanded in Figure 3.
As explained in our prior Biotech Developer review featuring Arrowhead Pharmaceuticals (NASDAQ:ARWR), the ALGN Range Index [RI] of 32 produced 106 profits (93% of 114), net gain %Payoffs of +10.9% under TERMD, a CAGR of +153% in 28 average holding day periods.
Real risk evaluation
So much for the “good side” of a buy proposition; what about the “bad side”?
As we condition the credibility of the upside price change forecast by comparison with actual experience, so too do we look to see how bad the downside might get. But with concern only during those periods of “long” holdings when committed capital would be at risk under the TERMD discipline. All other periods are irrelevant, shocking as they may be.
Figure 1’s data row tells what the worst case price drawdowns have been (an average of them), -3.3%, during all of each actual exposure period when they were to be held. What matters is how bad a fear of loss may get induced any time, not just whether or not it existed at the end of the holding. Investors will have varied reactions to the exposures, so there is no way to evaluate potential risk impact by historic outcomes. But some useful guidance may be provided by having knowledge of the maximum degree of intensity possibly becoming present.
Integrating the Good and Bad
One logically-simplified way to address the combination of stock price risk and reward is to weight each part by its probability and combine the two. The “Win Odds” of profitable position odds here for ALGN of 106 out of 114, or 93 out of 100 offer such a probability. One minus those odds, or 100 – 93 provides the loss probability weight. Thus .93 times +10.9% plus 0.07 times -3.3% produces a weighted net payoff of +9.9%.
To make this style of evaluation more comparable between varied investment opportunity situations, an integration of the likely holding periods used in the calculation is helpful. For ALGN the average number of market days required by all 114 positions of the sample was only 28 out of the maximum 63 possible, because of the high proportion of upside target prices reached.
A standard evaluation measure used in many capital planning decision situations is the expected net payoff stated in “basis points” of 1/100ths 1%, per day of capital involvement. On a 365-day calendar year +19 bp/day when sustained for a year doubles the original capital, or a CAGR of +100%. When a smaller-count of 252 market days makes up a relevant year, the fewer days are each proportionally more powerful, so only 14 bp/mkt day does the 100% equivalent.
The ALGN prior performances with expectations like those of today created results at a rate of 35 bp/day, very high and attractive.
Comparing Investment Alternatives
Comparison is the essence of evaluation. If the investing objective is to make capital as productive of future spend-able amounts as possible, using an odds-weighted bp/d yardstick can be helpful.
To that end Figure 3 includes the relevant MM forecasts and their prior outcomes for ALGN and the market-index proxy of the SPDR S&P 500 Index ETF. Also included are the average of some 2,700 current-day MM price-range forecast issues, and a ranked set of the day’s likely 20 best of those near-term wealth-building stocks under TERMD portfolio discipline.
All of these comparisons in Figure 3 have the same basic data as included in the row of Figure 1 for ALGN. That is expanded by the columns [O] through [R] to provide for odds-weighted bp/day price-prospect evaluation comparisons.
Competition from the market-index alternative SPY at this point in time is rather limited because of an unenthusiastic upside target outlook of only +5.5% at a CAGR of only +9% and an Odds-Weighted net prospect [Q] of +0.8%. That is better though, than the overall population of 2,711 where MM forecasts are a modest net decline (-2.2%).
Align Technology Inc. offers outstanding prospects for capital gains with strong odds for achievement in short periods of holding. Payoff potentials in basis points per day are exceptional. For further information please check my blog here on Seeking Alpha.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ALGN over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: Peter Way and generations of the Way Family are long-term providers of perspective information, earlier helping professional investors and now individual investors, discriminate between wealth-building opportunities in individual stocks and ETFs. We do not manage money for others outside of the family but do provide pro bono consulting for a limited number of not-for-profit organizations. We firmly believe investors need to maintain skin in their game by actively initiating commitment choices of capital and time investments in their personal portfolios. So, our information presents for D-I-Y investor guidance what the arguably best-informed professional investors are thinking. Their insights, revealed through their own self-protective hedging actions, tell what they believe is most likely to happen to the prices of specific issues in coming weeks and months. Evidences of how such prior forecasts have worked out are routinely provided in the SA blog of my name.