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)
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:
- 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.
- 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.
- 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:
- Provide income
- 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:
- Sell puts against a stock you want to own as long as you receive enough cash to buy the stock
- Buy the stock using collected premiums (or get assigned)
- Once you buy 100 shares of your favorite stock, start selling covered calls as long as you get assigned (sell the stock).
- 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.
(MORE: The Most Undervalued Dividend Stock in the Market)
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.
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Of course you may not be as fortunate as I was so far and you may sell a put option against a stock, let’s say at strike 20 dollars a share and the stock rapidly falls to $5 a share. You get exercised at 20 dollars a share while the current price is at $5 a share and the premium you received would be only 1.3 dollars.
I always try to contact the broker prior to opening an account. I call them, chat with them, and send emails with bunch of questions about investments available, platforms, margin, options trading, etc., and watch how the broker’s rep answers the questions and how fast they are. Responsiveness is very important to me.
Today the stock market proved to be artificially inflated by FEDs policy. It was apparent how weird it works when the central bank influences market and economy and how dangerous such interventions can be to the free market.
I still see great value in those stocks. Everybody is dumping them on fears of FED tapering its QE. No one looks at ending the QE as a good thing anymore. But they look only into the near future, short term impact. I am looking on a 20 year investment time horizon. From this perspective, today’s push down is yet another opportunity to take advantage from the FED’s mess.
Every great story will end one day. This is the case of my investments in Lending Club. Yes I am closing my account (or significantly reducing my exposure) with Lending Club and moving all available cash to equities.
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