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How to buy stocks cheap in today’s expensive market

If you are a dividend growth investor investing into dividend growth stocks, you may have noticed that the market is somewhat overpriced. You can read on many blogs complaints from dividend investors that it is very difficult to find fairly valued or undervalued stocks today.

I agree, that some stocks of my interest are expensive today. My favorite stock JNJ is way above the price I would be willing to pay to add more shares to my portfolio.

 
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As income seeking investors are fleeing from bonds and moving their capital into dividend stocks they will be driving the market and dividend stocks higher.

As you know, this trend will have a very negative effect to a metric every dividend investor is looking for – yield.

As the price is marching upwards, the yield goes the right opposite.

And therefore my favorite stock JNJ’s yield is now at 2.8%. In the past, it was around 3.5%. My threshold for committing cash in any dividend paying stock is 3.0%. As long as any dividend stock pays 3% or more in dividends I invest. JNJ is below my threshold.

 
(MORE: Getting Started With Dividend Growth Investing)
 

Money counting

Another metric dividend investors usually look at is P/E. Investors should evaluate P/E from many perspectives – historical, competitors, industry, etc. Typically when you ask any dividend growth investor they will tell you that they would invest in companies which trade at 20 or lower P/E.
My favorite JNJ trades at 21.03 P/E. Again above the threshold.

But I like this company and want to be adding more shares!

What shall I do?

You have basically the following options:

  1. Ignore it and invest regular amount of cash every month and reinvest all dividends using DRIP. In thin periods you will be buying cheaper and this will average the price and P/E down and yield potentially up.
  2. Wait when the stock falls or correct to more reasonable level or its earnings increase, and dividend will be raised up enough to yield 3% or more again.
  3. Or apply strategies which will artificially lower your purchase price.

 
(MORE: $10,000 Worth of Dividends (so far))
 

I like the third option – apply strategies which will allow you buying expensive stocks cheap.

Put selling strategy

Yes, I am talking about basic option strategy – put selling. Selling puts can provide you with two benefits:

  1. Provide income
  2. Lower your cost basis

A great trader Teddy Knight from Fullyinformed.com once wrote on her blog why she likes put selling and what strategy you should use. It is a very simple and powerful cash generating strategy:

  1. Sell puts against a stock you want to own as long as you receive enough cash to buy the stock
  2. Buy the stock using collected premiums (or get assigned)
  3. Once you buy 100 shares of your favorite stock, start selling covered calls as long as you get assigned (sell the stock).
  4. Rinse and repeat

I like the first part of the cycle. Sell puts as long as you collect enough cash to buy the stock. You buy the stock using other people’s money.

 
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That’s why I use options trading in my taxable portfolio (and I am planning on start using this strategy on my ROTH too). Not only I get income, but I can lower the cost basis of my stock and improve all metrics of that stock. I will be buying a lot cheaper than the current market price. I get a solid discount.

Buying dividend growth stocks cheaper

For example Safeway stock I wrote about in my previous post. I like the stock and I want to buy it. But let’s take a look at its metrics:


Current price – $33.04 a share
Current P/E – 18.28
Current yield – 2.30%

(Of course there are other metrics I usually look at, but I will list only these three for the sake of this article).

When I first added SWY in my watch list the above metrics looked like the following:


Price back then – $23.00 a share
P/E back then – 12.57
Yield back then – 3.47%

As you can see, at the beginning of the year, SWY was an attractive dividend stock, paying nice dividend, increasing dividends for 7 years with a payout ratio in its 40s and almost 20% growth rate.

 
(MORE: 5 Great Dividend Paying Stocks With Double-Digit Short-Term Dividend Growth)
 

Today, the stock doesn’t meet my criteria to invest in it. But by using options strategy I still can buy this stock cheaper. I started selling puts against SWY at the beginning of this year and here are the premiums I already collected:


+2.20 sold put in March 2013
+0.35 sold put in September 2013
+0.40 sold put in October 2013
+1.80 sold put in November 2013
——————————-
=4.75 total premiums received

This means that if I decide to buy this stock now or get assigned to this stock early or later, my purchase stock will be $28.29 a share. The metrics I look for will change as follows (being all other metrics the same):


Adjusted price – $28.29 a share
Adjusted P/E – 15.46
Adjusted yield – 2.83% (so I need to continue selling more puts)

 
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Don’t be afraid selling puts against the stock you want to own. There are only two possible outcomes which can happen to you – the option expires worthless or you will have to buy the stock at strike price minus received premium.

Both outcomes are good for you. This trade will always be a win-win trade.





6 responses to “How to buy stocks cheap in today’s expensive market”

  1. […] How To Buy Stocks Cheap in Todays Expensive Market – If you just aren’t willing to buy stocks at todays prices (although if you own for the long term I think you’ll still turn out fine buying at todays prices), then Hello Suckers wants to introduce you to the strategy of selling puts.  If interested in this strategy, I’d suggest doing some research because option trading does come with higher risk. […]

  2. CI says:

    It’s amazing what you were able to accomplishing selling puts for SWY. It’s had a rather large price runup, yet your basis would still be low. It seems your option premiums drastically outpace dividend payments.

    Take care!

    • Martin says:

      Hi CI, yes it does bring better income. But I still want to buy SWY, collect the dividends and premiums in the next round of put selling. Thanks for stopping by!

  3. Oh dear. Well, this proves I have no idea what I’m doing! (: I may try this with a smaller amount until I get it figured out. Very interesting approach!

    • Martin says:

      Nick, yeap try it. Take some money out and mentally assign them to a playing/learning trade, so you would be mentally ready for any outcome and try it. You won’t lose however because you will either buy a stock or the option expires worthless and you will repeat the process.
      If you need help, let me know to review the stock which you want and I can help you with the trade. You can also call me before you open the trade and we can discuss it.
      Martin

  4. Martin,

    I do like this strategy and you offer some good examples. I have only used covered call in my investments, but starting to look into put selling myself. I haven’t found the right stock yet for the strategy. Thanks for the examples.

    -RBD

    • Martin says:

      Hi RBD, yes it is very easy and simple. Just pick a stock you wouldn’t mind buying or you would buy anyway and go to your broker select 3 – 6 months ATM put option and sell it. Repeat as long as you get assigned. Just make sure you have enough cash in case you get assigned. That’s it.

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