The Blue-Chip Tech Stock You Didn’t Know Was Yielding 32%
Wall Street is becoming increasingly bipolar in its treatment of technology stocks. On one hand, you have “new generation” technology stocks like Twitter (NYSE: TWTR), Facebook (NASDAQ: FB) and LinkedIn (NYSE: LNKD), which have sustained huge losses over the past several weeks. On the other hand, there are blue-chip technology stocks such as Intel (NASDAQ: INTC) and Hewlett-Packard (NYSE: HPQ) that continue to trade with bullish patterns.
Much of this differential appears to be rooted in a flight to safety on the part of institutional money managers. As the Federal Reserve continues to taper its bond buying program and the prospect of higher interest rates weighs on investors, professional investors are moving capital into stable areas with reliable profits and cash flows. A transition in capital allocation out of growth and into safety appears to be hurting speculative tech names and supporting established and profitable tech companies.
Cisco Systems (NASDAQ: CSCO) stands to benefit from this trend as it continues to grind out reliable earnings and pays a 19-cent quarterly dividend for a current annual yield of 3.3%.
The company is scheduled to report earnings on May 14, and analysts expect earnings per share (EPS) of $0.48 cents, which is 6% lower than the same quarter last year. They expect EPS for fiscal year 2014, ended in July, to fall slightly to $1.99, but for fiscal 2015, they are anticipating CSCO will grow earnings by 6% to $2.11.
Investors have been skeptical of Cisco’s long-term growth prospects following a revenue warning in November. The company experienced weakness in emerging market sales, and this weakness was related at least in part to fallout from NSA spying allegations. While Cisco has some work to do to repair its international reputation, analysts still expect the company to grow earnings over the next year, and the stock is now trading at an attractive P/E ratio in the low double digits.
Shares found a bottom in December and have almost recovered all the losses following the November announcement. While the stock has slid a bit heading into the upcoming earnings announcement, I expect it to continue to rebound as institutional investors move capital into stable, cash-flow positive investment opportunities.
Today, we have an opportunity to generate a 32% per-year return by selling puts. Specifically, I want to sell the CSCO June 23 Puts, which are currently trading near $0.87 per share. If CSCO rebounds following the earnings report, these puts are likely to expire worthless.
By selling the puts, we can generate $87 per contract in income (each contract represents 100 shares). Since we will be short these put options, we will have an obligation to buy shares of CSCO at the $23 strike price should the stock remain below this level when the contracts expire on June 21.
Since we are receiving $0.87 per share from selling the puts, we will only need to set aside $22.13 ($2,213 per contract) of our own capital to purchase the shares.
There are essentially two outcomes possible for this income trade. Either the puts will be exercised and we will be assigned shares, or the puts will expire worthless, allowing us to keep the income free and clear.
In the first scenario, we will be purchasing CSCO at a net cost of $22.13 per share. Cisco hasn’t traded below this price point since March, so an opportunity to buy shares at this discounted price would be very attractive.
In the second scenario, our income of $87 per contract represents a 3.9% return over the $2,213 in capital that we need to set aside for the trade in 45 days. Our per-year rate of return would net out to 32%.
A 32% per-year rate of return is especially attractive in today’s low-rate environment, and it also comes with a safety net attached. We can sustain a decline in CSCO shares and still net a profit as long as the stock remains above $22.13. And if we wind up purchasing shares, we can turn around and sell covered calls against our stock to bring in more income.
This put selling strategy is an excellent way to generate reliable investment income in your account despite the turbulence in stock prices and the low interest rates. My colleague Amber Hestla has used this same strategy to “steal” thousands of dollars at a time from Wall Street. By performing these “heists,” as we call them, she’s delivering annual gains of 78.8%… 125.6%… and even 212.2%. Find out how you can do the same.