Geoff Considine, Ph.D | Jan 18, 2022 13:55
Union Pacific Corporation (NYSE:UNP) gained a total of Theory suggests that the market-implied outlook is likely to have a negative bias because risk-averse investors are willing to pay more than fair value for downside protection (put options). Considering this potential bias, the market-implied outlook for the next 2 months looks even more bullish.
The market-implied outlook for UNP for the next 5 months (calculated using options that expire on June 17, 2022) is also bullish, although the spread between positive and negative return probabilities is somewhat narrower. The annualized volatility calculated from this outlook is 25.7%.
Source: Author’s calculations using options quotes from E-Trade. The negative return side of the distribution has been rotated about the vertical axis.
Looking out a full year, the market-implied outlook calculated using options that expire on Jan. 20, 2023, slightly favors negative price returns. Considering the expected negative bias, this outlook is best interpreted as neutral. The annualized volatility calculated for this distribution is 27.7%.
Source: Author’s calculations using options quotes from E-Trade. The negative return side of the distribution has been rotated about the vertical axis.
The market-implied outlook is bullish for the next 2 months and the next 5 months, although the bullish tilt is smaller for the 5-month outlook. The 12.1-month market-implied outlook is neutral. The expected volatility rises slightly through the year.
UNP has provided investors with consistent long-term performance. The total return over the past year is close to, albeit slightly lower than, the annualized 3-, 5-, 10- and 15-year returns. The Wall Street analyst consensus is bullish, but the analysts see the potential upside as quite limited. The consensus 12-month price target implies a 7.65% total return.
As a rule of thumb for a buy rating, I want to see a 12-month expected return that is at least half the expected (annualized) volatility. With expected volatility in the range of 24%-28%, the 7.65% expected return does not make UNP look like an attractive risk-return proposition. That said, the analyst consensus price target from April was well below current price.
The market-implied outlook to the middle of 2022 is bullish, although the 12-month market-implied outlook is neutral. Heading into earnings, with a bullish Wall Street consensus rating and the bullish near-term market-implied outlooks, I am giving UNP a bullish rating. The fairly high valuation and the neutral outlook for the next 12 months suggest revising this analysis somewhere around the middle of 2022, however.
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