Wednesday, February 19, 2014

Income Investor Opportunities in 2014

Opportunities for income investors are likely to develop in 2014. 

Many uncertainties exist that could affect stock prices.  It is said that the market climbs a wall of worry so these uncertainties could explain the market’s relatively high value.  Yet, the market, so far this year, has been volatile.   If more volatility is expected, how can the income investor benefit?

Create a Target for Almost Dividend Machines.

I am going to create a list of stocks that just miss being Dividend Machines because of dividend yield alone.   Today, I want a dividend yield of 3.5% and many good companies miss on this dividend criteria.  Each stock will still have to meet the other three criteria.  I want to find the best income stocks among the group that pays a dividend of less than 3.5%.

During the various market swoons, I hope to find a potential Dividend Machine stock.  I am looking for a stock with a dividend yield of three percent that meets all the other criteria.   How much does the stock price have to go down to create a 3.5% yield?   Now I have a target price.  

As an example, let’s use Kimberly Clark (KMB.)   KMB is a solid Dividend Machine (see table) on every criteria except dividend yield which is 2.95% today; KMB closed at $108.78.   

At $100 the stock will have corrected a little over 8% and the yield will be 3.24%.   If you want to buy KMB with a 3.5% yield your target price is less than $90.  

It is interesting to note that KMB stock price was a touch over $91 just one year ago.

Have conviction in your stock pick.

You have to have conviction in your Dividend Machine pick.   When a stock’s price craters enough to change the yield from 3% to 3.5% you wonder if you should buy that stock?  I depend on the other three criteria to help me stick with my conviction to buy.

Trade yield for covered call potential.

Cheating on the yield of a very good stock is not to be dismissed.   Once you find a stock with reliable and growing dividends and with a low D/E ratio, you could make an argument for buying it on a correction but before it hits 3.5%.    This is the more common scenario.   A good stock corrects but not enough to be a Dividend Machine so I miss a good opportunity to add.

I find more comfort buying a solid stock at less than a 3.5% yield when I can squeeze more income from covered calls.    Perhaps one in ten stocks of this quality will have covered calls, but they do exist.

Let’s use Caterpillar (CAT) as an example.  CAT misses being a dividend machine on yield alone (see table #2)  Today CAT closed at $96.21 with a yield of 2.47%.   CAT needs to weaken to $70 or less for the dividend to yield 3.5%.     The last time CAT traded at under $70 was September, 2011.

However, CAT has provided me with covered call opportunities in the past.   I believe covered calls will be available in the future but I cannot be sure.   So I will decide when the combination of dividend income and covered call income make buying more CAT a wise income investment.

Today, CAT traded several May $100 strike price covered calls for a premium of $1.84 (see table #3.)    If you bought CAT today at $96.21 then sold the May call your income yield for the year and the call buyer does not take your stock, will be 4.4% ($2.40 dividend + $1.84 call premium/$96.21 cost basis.)  

KMB and CAT are examples of opportunities that may come in 2014.

The Money Madam