Honeywell: Focus On Higher Margin Operations Likely To Help Shares Ramp Up
Geoff Considine, Ph.D | Oct 18, 2021 08:13
Honeywell (NASDAQ:HON) shares saw a substantial rally at the end of 2020, but YTD the total return for the diversified technology and manufacturing company is only predictive value of the consensus price target.
constructs the Wall Street consensus outlook from ratings and price targets of 26 analysts. The consensus rating is bullish and the consensus 12-month price target is 10.2% above the current share price.
Source: Investing.com
The Wall Street consensus outlooks calculated by ETrade and Investing.com are both bullish, with expected 12-month total returns (including the current forward dividend yield) of 10.4% and 12%, respectively. Whether or not this is attractive depends on the expected risk level, which is calculated in the next section.
Market-Implied Outlook for HON/h2
I have analyzed call and put options on HON at a range of strike prices, all expiring on Jan. 21, 2022, to calculate the market-implied outlook for HON for the next 3.1 months (from now until the expiration date). I have also generated the 8-month market implied outlook from options expiring on June 17, 2022.
The standard presentation of the market-implied outlook is in the form of a probability distribution of price return, with probability on the vertical axis and return on the horizontal.
Source: Author’s calculations using options quotes from ETrade
The market-implied outlook to Jan. 21, 2022 is generally symmetric, although the maximum probabilities are clearly tilted to favor positive returns (a bullish indicator). The peak probability corresponds to a price return of +2.6%. The distribution is somewhat negatively skewed. The probability of having a return of -20% over this period is about twice as high as having a return of +20%, for example. The annualized volatility calculated from this distribution is 22%, which is low for an individual stock.
To make it easier to directly compare the probabilities of positive and negative returns of the same magnitude, I rotate the negative return side of the distribution about the vertical axis (see chart below).
Source: Author’s calculations using options quotes from ETrade. The negative return side of the distribution has been rotated about the vertical axis.
From this view, it is evidence that the probabilities of positive returns are consistently higher than for positive returns of the same scale, for a wide range of the most-probable returns. This is a bullish outlook for HON.
Theory suggests that the market-implied outlook is expected to have a negative bias because investors, in aggregate, are risk averse and, as a result, are willing to pay more than fair value for put options. In addition, dividend-paying stocks tend to have a negative tilt in the market-implied outlook because the dividends reduce the potential price appreciation. Considering both of these factors makes the market-implied outlook appear even more bullish.
Looking out to the middle of 2022, the 8-month period from now until June 17, 2022, the market implied outlook is generally neutral but still looks slightly bullish when the risk aversion bias is considered. The annualized volatility derived from this distribution is 24%.
Source: Author’s calculations using options quotes from ETrade. The negative return side of the distribution has been rotated about the vertical axis.
The market-implied outlook for HON is bullish, with the strength of the bullish signal becoming somewhat muted by the middle of next year. It is common for the market-implied outlook to express a diminishing directional signal for longer time periods, for which there is simply less confidence in the outlook. The expected volatility, 22% to 24%, is on the low end for individual stocks.
Summary/h2
The outlook for HON is generally bullish, as the firm ramps up higher-margin business lines in software, computing, and clean energy. The Wall Street consensus outlook is bullish, with expected 12-month total return of 10.4% (ETrade) to 12% (Investing.com).
While this is not an especially high level of expected gain, the risk level for HON is quite low, with expected volatility in the range of 22% to 24%.
As a rule of thumb for a buy, I look for an expected 12-month return that is at least half the expected (annualized volatility). HON is right about at the cutoff. The market-implied outlook to early 2022 is bullish, shifting to slightly bullish at mid-year. My overall rating for HON is bullish.
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