Is This High-Yielding Blue Chip a Trap?

Income investors, like all investors, are susceptible to traps.

One of the best-known is the value trap. This occurs when an investor buys a stock that’s underpriced based on some quantifiable measure of value — like a low price-to-earnings (P/E) ratio — only to see that stock fall further or simply trade sideways for months or years.

The appeal of buying “cheap” stocks is largely dependent on their undervalued status and the hope that, over time, other investors will see this disconnect and send prices higher. When this doesn’t happen, it can feel like your money is trapped in an investment that looks attractive for the long term but is going nowhere in the short term.

Cisco Systems’ (NASDAQ: CSCO) long-term price chart provides a textbook example of a value trap.

CSCO Stock

The stock has traded in a relatively narrow trading range for about 12 years. During that time, it has consistently underperformed the broader market, returning less than 10%, including dividends, while the S&P 500 nearly doubled. That’s a huge missed opportunity for anyone who bought CSCO back in 2004 thinking it offered a great value.

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A lesser-known trap is the income trap. This is where investors buy a stock due to its above-average income payments, only to see their dividend cut or even eliminated. 

As many investors wonder if we are in the early stages of a bear market, it’s reasonable to ask if we can avoid these traps. 

One way to do so is to add a relative strength (RS) screen.

RS is a measure of momentum that compares an individual stock’s performance to the rest of the market. 

One of the most popular methods of measuring RS ranks all stocks by their six-month performance and assigns each a rating between 0 (worst performer) and 100 (best performer). Stocks with the lowest ranks are likely to underperform the broader market over the next six months, while high-ranked stocks are likely to outperform.

By buying income or value stocks with high RS, we minimize the risk that our money will be trapped in an underperforming investment.

One stock that offers value, income and high RS is blue-chip AT&T (NYSE: T)

The Perfect Storm of Value, Income and Momentum

AT&T is the second largest mobile phone service provider in the United States with more than 128 million subscribers. It also offers satellite TV programming and Internet access.

Fundamentally, T is undervalued based on a number of indicators, including the P/E ratio, price-to-book (P/B) ratio and price-to-free-cash-flow (P/FCF) ratio.

This is surprising given that earnings growth is accelerating. Over the past five years, EPS growth averaged 3.9% a year, but it is expected to increase to 5.1% a year for the next five years.

I don’t believe AT&T is a value trap, though, due to its high RS. A RS of 70 or above is generally considered a buy signal. T has an RS of 87, meaning it is outperforming 87% of all stocks in the market right now and is likely to continue doing so.

But I think the most appealing thing about AT&T is its high income potential. 

The company has paid a dividend for 32 consecutive years. It currently pays out $1.92 per share for a forward yield of more than 5%.

It is also one of just three stocks in the S&P 500 with what I consider a “safe” yield above 5%. That means the dividend is less than the amount of cash flow from operations. Since companies pay dividends from cash flow, I believe this is the most conservative metric to apply. And of the three stocks with “safe” 5%-plus yields, T is the only one expected to deliver significant growth over the next five years.

Earn an Additional $700 From AT&T Instantly 

AT&T’s next quarterly dividend payment of $0.48 is expected in early April. But when I recommended buying shares of the company recently, I told traders how they could skim an additional $0.70 per share in income instantly. 

So, if you purchased 1,000 shares, that’s an additional $700 in your pocket. And you could potentially do this six times a year with AT&T. That’s an extra $4,200 a year in addition to regular dividends and capital gains.

I do this regularly with a number of stocks, skimming a few hundred — even a few thousand — dollars from the stock market. In fact, last year I made $46,360 doing it.

Although it may not sound like it, what I do is completely legal.

Plus, it’s easy to do. The money is just sitting there. If I don’t take it, someone else will. I just beat them to it.

While this may surprise you, it’s considered a conservative strategy — safe enough for widows and orphans. And almost anyone can do it, no matter their account size.

I’ve already shown it to hundreds of people… from young couples struggling to make ends meet to retirees looking for that extra “oomph” to their income.

It may sound a bit confusing, amoral or just too good to be true, which is why I made a video to show you how easily you can do it too. Click here to watch.