Sunday, October 12, 2014

What to do with Microchip Technology MCHP?

One of my earliest Dividend machines took a terrible tumble on Friday.   The tumble was deserved. Although I do not use P/E (price earnings) ratios to determine if a stock qualifies as a Dividend Machine, P/E is important when you try to decide what to do with a holding that crashes like MCHP did on Friday.

Microchip's P/E soared over the past few years and this was during a time when MCHP was absorbing an acquisition.  I was tempted to sell it because the yield on this inflated stock price was well below what I could get from another stock.    On the other hand, my cost basis of $33.69 is well below the current price.

During these times when traders buy stocks that are rumored to be have a lot of growth, MCHP had good rumors and a high stock price and a high P/E.    Covered calls are the obvious strategy to improve income but you can only sell a call when someone else wants to buy it from you.   For quite a while, MCHP had no calls.   Lately calls have been better and I have one half of my position on call (October $50.)  That means I could not sell those shares if I wanted to until the calls expire.

Does a lower P/E mean I should buy?

I will likely hold onto the other shares as this stock is still a strong income producer.  Unless covered call income is compelling, which to me is a call premium yield of at least 2% or about $.80 per contract, I will not add to my position.

Even if the stock price erodes enough that MCHP's dividend yield is more than 3.5% and the P/E is less, I will not add.  My reason is I need dividend growth and while MCHP has consistently increased the dividend, the increases have been meager.     But then I get the capital gain if the call buyer takes part of my position and that makes up for the meager dividend increases.   But I really doubt that my stock will be called away.   Therefore, I will look for new calls and hold.

A stock with a 3.1% dividend yield, low debt, a history of increasing dividends, and earnings that exceed the dividend payment, and has occaisional covered call income, is not a bad stock to hold.