Monday, April 20, 2020

PRU Buy-write + Dividend makes a senior happy

  •  Buying on fundamentals remains a good strategy for conservative, ordinary investors.  We like real numbers that we can understand rather than complicated stock analyst stock picks.  We want yield.
  • They say if you like it at $100, you should still like it at $50.  These words of advice are based on the fundamentals you used to buy a stock in the first place.  Unless the fundamentals have changed, you should have some confidence in your buy.
  • When you have to put your money to work for income, the underlying stock has to have a solid, safe and preferably growing dividend.
  • Using a Buy-write strategy can boost your income.  Adding to your position at a lower cost basis is one way to put your cash to work and when you can simultaneously sell (write) a call on those new shares, you can pocket the quarterly dividend and a call premium.  If you are called away, you still own the shares from your previous buys.

The example I site today is Prudential, symbol PRU.  I published a post on PRU earlier this year.  My original basis is $96.00  and I added today at $53.80.  Let's review the PRU fundamentals and then look at the additional shares I added and the calls that have enhanced my income.

PRU Fundamentals:  

Buying a stock with a high dividend yield is scary.  I have to be sure the stock I bought will continue to pay the dividend through thick and thin.   I can handle price cuts, but I cannot stomach losing income.

Some of the metrics I used are:  
  • Earnings per share have to be greater than the dividend paid out.
  • Revenues have to be growing enough to support Earnings per share.
  • We want a solid balance sheet
  • In this market, we don't want to pay a premium for our shares
Here is how PRU stacks up.

PRU Earnings Dividend
 Earnings > Dividend $10.27 $4.40
 Debt to Equity 0.35
 Dividend Yield 8.18%
 3 Yr. Rev. Growth 2.86%
 P/E Ratio 5.6

I like what I see.  A very hefty yield on shares that are down by half from a 52 week high of $106 but off their recent lows of $38.62.   Is the dividend safe?  Nothing is perfect but even if earnings are cut in half, PRU can still cover the dividend.  D/E (debt to equity) ratio suggests a very solid balance sheet.  Even with the headwinds, it's is highly likely PRU will not go out of business.

First Buy/write strategy:

A Buy/Write strategy as defined by Investopedia is:

"Buy-write is an option trading strategy where an investor buys a security, usually a stock, with options available on it and simultaneously writes (sells) a call option on that security. The purpose is to generate income from option premiums."

Read on to learn how I used a Buy/Write strategy on Prudential. 

My buys prior to today illustrate that I stick to my knitting.  I am not publishing this as a theoretical view.  I actually add as a stock goes down when I like the fundamentals.  Prudential is the stock. 

  • Feb. 6 and 12 = $96
  • Feb 28 =$74.50
  • Mar 12 = $48.30
I received the dividend of $1.10 on the Feb 6 and 12 buys as the stock was ex-dividend 2/14.  

On March 2, I sold (write) calls on the Feb 28 buy.  I chose the May 15 expiration.  PRU has not announced the next ex-dividend date.  However, looking back at the last three May ex-dividend dates, they were all before this call expires.  Since most calls expire without being assigned, I expect to receive a dividend on all my shares even those that are on call.  

I picked a strike price of $82.50 because I wanted at least a 10% gain on my shares if they are called away.  Remember I am using the shares with the $74.50 basis.  Being called away is not the outcome I want but it does happen and if I am going to lose such a prodigious dividend yield, I better bank a good profit.   

The premium I received on that March 2, 2020 expiration with an $82.50 strike price was $2.29.  That income alone is like receiving two additional dividend payments.  I call that a compelling strategy.   Who knows what is going to happen but since PRU is trading around $53.80, it has a long way to go to get to the strike.

I will sit with a stock that is below my cost basis just for the dividend.  If PRU does get back above my $74.50 basis, I will sell more calls.

As far as the $96 basis goes, I don't want to sell.  I want that juicy dividend.  

Today's Buy/Write

I added to PRU at $53.80.  I immediately sold a call on those shares.  

Two expiration dates had calls that expire after the next expected dividend date.  The May 15 expiration with a $62.50 strike was trading around a $1.00.  The dollar premium is an additional 1.85% of yield on top of PRU's dividend yield.

The expiration date I liked even better was the June 16, 2020 $62.50 because the premium was $2.00.  I sold (write) that call immediately. 

Price on Open Call Expiration 
PRU $53.78 6/16/2020
Cost Basis:   4/20/2020 $53.80
Strike Price: $62.50
Call Premium:  $2.00
Dividend  Expected before 5/15 $1.100
Call Yield on Basis 3.72%
Call + Dividend Yield on Basis 5.76%
$ Gain if Assigned $11.80
Max Return  if Assigned 21.93%

While the over 21% max return is impressive, the stock has to be called away to get that return.  What is more important is the income created from PRU.  On this lot of shares alone, I have already received $2.00 per share and I fully expect to receive the quarterly dividend of $1.10 per share.  Combine those two sources of income and the yield for this 2 month strategy is 5.76%.  

On the original buys, I received one quarterly dividend already plus the call premium of $2.29 and I expect to receive the dividend on all the shares.  I don't like being down by half, but I am hoping the PRU can continue to deliver the dividend and maybe even keep up the 10% dividend growth.

I constantly work my stocks to create this kind of income.  Sometimes I add tiny numbers of shares until I get 100 shares that pay me a dividend on which I can sell (write) a call.  Where else can a senior get income unless you  become a packer at Publix.

Good income investing.

M* MoneyMadam

Disclosure:  Long PRU with calls

Tuesday, April 7, 2020

Unintended consequences of Corona - Positive view for income investors

Unintended consequences of Covid-19 include less crime, reduced spread of communicable diseases, fewer auto accidents.
  • Fewer miles driven makes for few accidents
  • Auto insurers should benefit from fewer accidents and payouts.
  • Looking for a stock with an A rating.
  • Looking for an insurance stock with a high yield
  • Looking for a stock that is optionable
Sad as this Covid-19 experience has been for everyone, there are some positive consequences.  Governor Cuomo commented on a reduced crime rate.  With the social distancing and the wearing of masks and the unrelenting hand washing, we have to be reducing the incidence of communicable diseases in general.

Another unintended consequence is driving behavior. With stay at home behavior, people are driving and even riding in cars fewer miles and fewer hours.  Fewer miles driven translates to fewer accidents.  This is an interesting article on the impact of recessions and other events on traffic. .   This morning on my local news channel we learned that auto accident deaths in our State are down.

With out a doubt we will have fewer auto accidents and that should lead to fewer claims paid by insurers.  That makes me look for an auto insurer to add to my portfolio.

In my portfolio, I own Prudential, symbol PRU.  But I no longer own a property and casualty insurer.  In 2017, I wrote up a post that applied my dividend machine fundamentals to a group of insurers.  I ended up owning several of those but they were all either called away on options or I sold them for other reasons as their prices increased.  That link is below.

Today, I looked at a bunch of insurers including:  MKL, SAFT, HIG, CB, MET, AIG, MCY, PRA, and CNA. Out of this group, the best yield is MCY and it is the most pure property and casualty play.  SAFT has a good yield and generates most of its business from private passenger auto insurance.  But, SAFT is limited to the North East.  

Another factor that determines which of these stocks I want to pursue is their credit rating.  For insurance companies there are several credit rating agencies.  AM Best and Fitch are two that are well known.  While MET has an A+ rating by AM Best it really is not as pure a play on auto insurance.  Take a look below at the credit rating categories of insurers.

CategoriesRating symbolsRating notchesComments
Assigned to insurance companies that have a superior ability to meet their ongoing insurance obligations
Assigned to insurance companies that have an excellent ability to meet their ongoing insurance obligations
Assigned to insurance companies that have a good ability to meet their ongoing insurance obligations
Assigned to insurance companies that have a fair ability to meet their ongoing insurance obligations
Financial strength is vulnerable to adverse changes in underwriting and economic conditions
Assigned to insurance companies that have a marginal ability to meet their ongoing insurance obligations
Financial strength is vulnerable to adverse changes in underwriting and economic conditions
Assigned to insurance companies that have a weak ability to meet their ongoing insurance obligations
Financial strength is very vulnerable to adverse changes in underwriting and economic conditions
Assigned to insurance companies that have a poor ability to meet their ongoing insurance obligations
Financial strength is extremely vulnerable to adverse changes in underwriting and economic conditions

SAFT carries a BBB+ rating.  Whereas, MCY carries an A rating.  Both are acceptable but I like A over triple B plus.  

Once I narrowed this group down, I look at dividend fundamentals that I use for every dividend stock I add.  Here is how MCY stacks up.

MCY Annual EPS Annual Div
  Earnings>Dividend $5.78 $2.52
  Debt to Equity Ratio 0.23
  Dividend Yield 6.45%
  3 Yr. Rev. Growth
  3 Yr. Div. Growth 0.03%
  Cash Flow/Share $9.39
  P/E Ratio 6.5

Mercury General has a long history and that is so useful when making the decision to add a new position.  Looking at the table above, MCY shows me that earnings are adequate to pay the dividend and that yield is hefty at 6.45%.  I also see a D/E ratio that is low but typical of insurers.  Revenue has adequate growth and P/E ratio is down right cheap.  

The only negative I see is the lack of dividend growth.  I will take the big yield on a solid balance sheet while I work shares to maximize income while this low accident rate catalyst works.

When I add a new position, I want good yield, a solid balance sheet, a solid history of dividend payments.  Looking back on their history during the 2007-2009 market disruption, I see a stock with a solid history of paying the dividend through thick and thin.  

      Graph from

I also like a stock that is optionable because I make a lot of extra money selling calls on my dividend stocks.  I don't want to necessarily lose all my shares should I be called away, therefore, I sell calls on only a portion of my position.   Each call requires 100 shares.  If I own 500 shares, I might sell 2 calls and keep the other 300 shares un encumbered by a call option.

I started this article on 4/6/2020 but executed the trades today 4/7/2020.  As soon as I bought my shares, I sold this call.

Price on Open Call Expiration 
MCY $40.11 6/19/2020
Cost Basis:   4/7/2020 $39.90
Strike Price: $45.00
Call Premium:  $1.25
Dividend  6/16/2020 $0.630
Call Yield on Basis 3.13%
Call + Dividend Yield on Basis 4.71%
$ Gain if Assigned $6.98
Max Return  if Assigned 17.49%

We all hope this crises is shorter lived than we currently expect.  Moreover, we hope the underlying business of America goes on. Currently the options buyers are out there and that is most important for income investors, like me, who use a covered call strategy for income maximization.

M* MoneyMadam

3/29/2017 Post on Insurers

Expect to add MCY and expect to sell calls against a portion of the position.

Wednesday, April 1, 2020

What should retirees do?

  • Understand impact of crisis from Government printing trillions upon trillions of dollars
  • Adjust investment plan to tilt toward income growth
  • Use dividend stocks with dividend growth history over bonds 
  • Employ a covered call strategy on selected dividend stocks

Most of us are income investors who also know in the best of times the need for more income in the future is expected.  Good financial planning means you include this goal when picking your investments.

We will get over the Corona Virus impact but as James Mackintosh said in the Wall Street Journal:  "There'll be debt to pay after crisis."

What will cause problems for us?

  • Government just printed 2 Trillion Dollars
  • With more and more dollars out there, those we have are worth less
  • In addition we have cut down on making things
  • We will have to spend more of our dollars buying scarcer goods whose prices will probably rise. 

This is not a difficult scenario to swallow.  There may be pockets such as energy that will not respond in this way.  "Stuff" however will cost more.  If you believe in this scenario then the question is:

What to do.

  • Buy as many scarce goods as you can
  • Accumulate more dollars as you will need them to live on
  • Stimulate increasing supply to get supply to catch up

In our society, a capitalist society equilibrium will win, but that takes time.  And the individual investor has little influence on stimulating the supply chain for "Stuff."  We could hoard goods to hedge against increasing prices.  We could go back to work to accumulate more dollars to put to work so we can afford rising prices.

When you can't go to work, your money goes to work.  Bonds have been a safe haven but are not a good investment.  Safe Bond yields at half of a percent make you think of buying higher risk bonds and those carry a good chance of losing value.

Stocks with dividends and a history of dividend growth are a better way to earn the 3 or more percent yield you need.  You know 3% on a million dollar portfolio is only $30,000 per year.

Real estate is an investment class of its own.  Ordinary retired investors use REIT stocks as a proxy for owning real estate and indeed REIT's provide a lot of yield.  REIT's are complex; you need to know what  you are doing.

Another source of income for ordinary investors is to sell, also known as write, calls on stocks you own.  This is a bit complex but not that difficult if you follow some guidelines.

I posit the best investment for retirees who want income to grow and want more than just 3-4% is dividend stocks with a covered call strategy.  I cannot reinforce this enough.  I make my income off of dividends and covered call premium income on those dividend stocks.  You can easily increase your 3-4% by another 1-3% by employing this strategy.

Never before have dividend stocks been so cheap.  The market will continue to bump along the bottom while we work through the crises.  Quality dividend stocks are available.  Here is what I look for:

  • Dividend yield 2.5% or more
  • 3 Yr Dividend growth rate 4% or more
  • Optionable
  • P/E ratio (trailing) 15 or less
  • D/E (debt to equity ratio) 1 or less
  • No dividend reduction if paying a dividend in 2008

Let's look at an example available today.

Intel, symbol INTC, is a common holding in a conservative investor's portfolio.  I certainly have been in and out of Intel for years.  My previous cost basis is in the mid teens.  As INTC corrected recently, I nibbled at around $56.  That was about 19% below the recent high of $69.29.  Intel corrected even more and those shares are under water.  Today INTC is trading around $53.00- $54.00

The table below shows the quality of Intel's fundamentals.  Notice that earnings and P/E ratios are based on trailing earnings.  Intel's P/E ratio is 10.99.  We do not know how earnings will be affected by this crisis so P/E's will change.

I call this a quality company because even if earnings are cut in half, they can still cover the dividend.  With a D/E ratio of only .37.  I think the dividend is quite safe.  

One of the most important pieces to building a portfolio for retirement is to have about 35 stocks and to have enough of a position in a stock that you can work covered calls.

INTC Annual EPS Annual Div
  Earnings>Dividend $4.78 $1.32
  Debt to Equity Ratio 0.37
  Dividend Yield 2.47%
  3 Yr. Rev. Growth 7.22%
  3 Yr. Div. Growth 8.90%
  Cash Flow/Share $7.41

But, and it is a big but, living on a dividend yield of 2.47% is not easy.  One would have hoped that with the price correction, the yield would be higher.  On the other hand, I like the quality of the fundamentals enough that I can swallow having this name in my portfolio.

I sold a call today on those new shares.  I picked a strike price of $60 so if I am called away, I make capital gains.  If I am not called away, I pocket the premium.

I picked an expiration date after the next ex-dividend date which is May 6, 2020.  Provided my shares are not called away before the next ex-dividend date, I get to pocket the dividend and the premium.

Using my Cost Basis Price on Open Call Expiration 
INTC $53.44 5/6/2020
Cost Basis:   12/3/2019 $56.00
Strike Price: $60.00
Call Premium:  $1.25
Dividend  5/6/2020 $0.330
Call Yield on Basis 2.23%
Call + Dividend Yield on Basis 2.82%
$ Gain if Assigned $5.58
Max Return  if Assigned 9.96%

Basis is price on open Price on Open Call Expiration 
INTC $53.44 5/6/2020
Cost Basis:   Price on Option Contract Open $53.44
Strike Price: $60.00
Call Premium:  $1.25
Dividend  5/6/2020 $0.330
Call Yield on Basis 2.34%
Call + Dividend Yield on Basis 2.96%
$ Gain if Assigned $8.14
Max Return  if Assigned 15.23%

Looking at INTC's fundamentals, I am willing to risk not losing the shares even though I am underwater for now because I am adding a quality stock with low debt and a reasonable dividend yield.

Of course all this data will change over the coming months.  But even if earnings are cut in half, INTC should still be able to maintain the dividend.  Even between 2008 and 2009 INTC was able to increase their dividend 3.2% while earnings were cut by 16% during the same time frame. When I received that $1.25 premium, that is equivalent to three extra dividends.  

If I hold Intel through a full year, and sell only this one call, my income yield on the $53.44 is up to 4.7%.  Now that is an investment I can live on.  Just think how you can milk your stocks by doing more than 1 call per year.  With multiple lots (you must have 100 shares to sell one option contract) you can roll the expiration dates as the market provides opportunities.

With the market so very volatile, there is no way to tell how this trade will unfold;  let's just see what happens.

You have to do your work.  On my first screen I found 81 stocks, but then on closer inspection I found maybe 10 stocks where I could work this strategy.  I wrote up Intel because it is such a quality stock to add on weakness or to start a position and because I have had such success selling calls.

M* MoneyMadam
Disclosure:  Long INTC with calls