Trading Corner: Drug Services Company Bounces off Important Support

With the weak economy, drug makers have been scaling back their drug development plans. The slowdown has trickled down to the so-called contract research organizations (CRO), which help pharmaceutical and biotechnology firms manage the necessary clinical trials for a drug to be licensed and marketed.

Many CRO’s have tumbled, with short-term bearish sentiment hanging like a cloud over the group.

#-ad_banner-#Despite this sentiment, the 14 analysts who follow Covance Inc. (NYSE: CVD) expect a sterling performance next year. On average the analysts expect revenues to increase about +10%, to $2.05 billion from $1.86 billion. They project annual earnings per share to rise +16.7% to $3.06, from $2.62. The stock’s current price-earnings (P/E) ratio is 18.1. I consider it a bargain when I can buy a stock with a P/E that is in line with its projected earnings growth rate for the next year.

As the chart below shows, CVD traded as high as $58.95 in mid-September. On Wednesday, December 9th, it hit a low of $50.05.

The $50 level is significant in a number of ways. First, notice that CVD found resistance at $50 between June and August. Since old resistance should be new support, technical analysis theory says the shares should find buying balance sheet at this level. Of course, $50 is a round number, and stocks often find what I call round-number resistance and support at these levels.

As I write this at about 11:00 A.M. Eastern Time, the stock is up about $0.50 and is probing $51. It appears that buying interest has emerged at $50. Daily stochastics is at 33 and is at its most oversold level since March, when CVD bottomed along with the S&P 500.

There is some resistance at about $52, the previous support between September and December. Given the strong fundamentals, I believe this resistance will be penetrated. I am setting a target of $56.95. My stop loss is $47.35, just below the rising 200-day moving average.

If the stock hits my target, the gain will be in the order of +11.7%. If the stop loss is touched, the loss will be about -7.2%. That is a risk/reward ratio of 1.63 to 1.

In the interest of disclosure, on Wednesday, I took a small call option position in the January 50s. I bought my calls when CVD held $50 and had a weak bounce.

Action to Take:

  • Buy CVD at 1PM Eastern Time on Thursday, December 10th, with a limit order at $51.50
  • Set an initial stop loss at $47.35
  • Target Price $56.95
  • Potential Profit = +11.7%