Sunday, March 31, 2013

Dividend Stock Correction?

Are you worried about a market correction in dividend stocks?   Should you be a buy and hold investor and try not to feel awful when a stock you hold hits highs and then retreats?   Look at Apple, people are kicking themselves for being greedy.  If you don’t hold, which companies should you sell and why?  Below is an outline of the strategy I use.

My decisions about how to handle dividend stocks at their high are driven by the concept of increasing the “yield on my available capital.”    If I invested $10,000 in a stock with a dividend yield of greater than 3% and now due to the stock price going up, my $10,000 is worth $20,000 but the yield on that $20,000 is less than 3%, I want to make a change.    I want to make sure that my “available capital” of $20,000 generates more income. 

You are the manager of your resources.  Good managers use their resources wisely; in our case using your resources wisely means getting more income from your available capital.    My approach is outlined below.

Stock Price
5 year high
Dividend Yield
Less than 3%
Dividend Growth
More than 7%
Covered Calls
More than 1%
Stock price and current yield of dividend stocks.

Dividend stocks are at their highs and it is appropriate to have a strategy.   If you own dividend machines that are at or near their five year high and have a current dividend yield of less than three percent, target them for further evaluation.

Dividend growth rate.

Look at the growth rate of the dividend.    How much did they pay per share 5 years ago and how much do they pay today.   With only those two pieces of information you can calculate how much the dividend has grown.  If the dividend growth rate is seven percent or more per year, then you may want to keep the stock and add to it if there is a market correction.  A seven percent increase every year for 10 years means your income will have doubled in 10 years.    

Let's use Chevron, CVX, as an example.   On Thursday, March 28, 2013, CVX closed at            $118.82 which is just below the multi year high of  $121.56.  At $118.82 the yield is 3.02%.   Chevron has a stellar history of dividend increases.   March 10, 2008 the quarterly dividend was $.58 per share and this year on March 11, the quarterly dividend was $.90.   That represents a $.32 increase.  Over the past 5 five years the dividend growth rate was 12.8% per year. 

Will CVX's stock price continue to slip?  It may.   The 52 week low is $95.73.   Your dividend yield at that price would be 3.76%.    

This is an example of a stock that I will add to on dips.

Can covered calls add enough to yield more than 3%?

If the dividend increase is less than 7%,   consider boosting your income by selling covered calls on the stock.   You risk losing the stock but that may be alright if the stock is at a 5 year high.  You, of course, have to be prepared to find another investment that yields more than 3%.

Conagra Foods, CAG, is a good example.  CAG closed at $35.81 on Thursday.  CAG's dividend yield at that price is just over 3%.   CAG's 5 year stock price high is $35.91.  CAG has increased the dividend every year but the rate hikes equal only 6%.    Can I create more income by selling a covered call with a strike price that is greater than the 5 year high?  

I found a June, 2013 call with a strike price of $37 or one point above the high.  The premium from the call is $.45 which boosts my annual income from $1.00 to $1.45 for a yield of 4%.  If I lose the stock, I will have a significant gain.   All good news.

If you can create an extra one or two percent income by selling  covered calls on a stock to equal a yield greater than three percent, then keep the stock and search for covered calls where the premium is equal to one percent.

If you cannot create the extra income with covered calls, then sell it and move it to an investment that pays more than 3%.   You can sell the stock quickly and wait to find another investment, or you can set a sell stop just in case the stock price goes down in your absence.  Another technique is called buying a put but I do not cover that technique in this blog.

Buy and Hold?

Try not to use emotion to decide if you are a buy and hold investor.  Buy and hold as a strategy, versus actively manipulating a stock portfolio, is favored by conservative investors.  Yet, even the strongest willed investor hates to see a stock that was at a high go down.   Therefore, I use this dynamic buy and hold strategy.   My goal is always to increase my income.  Once you target a dividend stock as one you might want to sell, considered the guidelines discussed in this post.