A Blue Chip Yielding 11.9%?
From the upcoming presidential election to impending interest rate decisions, investors will be facing plenty of uncertainty over the next few months. In this environment, the best course of action, in my opinion, is to remain focused on finding high-quality stocks with higher-than-average income.
Ford Motor (NYSE: F) is a perfect example.
Concerns arose in the sector recently when a report showed auto sales had declined. Sales, which hit a record 17.47 million vehicles in 2015, fell to an annual rate of 16.98 million in August.
Ford Chief Economist Bryan Bezold noted sales have plateaued after steadily rising following the 2008-2009 recession. He attributed the auto industry’s outperformance to pent-up demand that has now played out. Ford expects sales to be lower in 2016 and 2017.
The good news is that management says it can make money at significantly lower levels of sales. Ford’s CFO recently told analysts even if U.S. auto sales fall as low as 11 million annually — a 37% decline from last year’s record — he believes the company can break even.
Profitability, even when sales are low, is expected to be a result of Ford’s ability to lower its costs as demand declines. The company said it can cut costs by $3 billion during the first year of an industry downturn, and could even improve profits during the second year if the downturn continues.
The fact that Ford has a plan in place to weather a downturn is a huge positive for shareholders. And strong operating results should help the company absorb unexpected costs, such as the recall related to faulty door latches. Earlier this month, Ford cut its 2016 pretax profit forecast from $10.8 billion to about $10.2 billion due to the recall turning out to be more expensive than anticipated.
Analysts expect the company to report earnings per share (EPS) of $1.83 this year and $1.82 next year. To be conservative, we can use the most pessimistic forecast, which is for EPS of $1.53 next year. EPS growth is expected to average 9% a year. Assigning a price-to-earnings (P/E) ratio of 9 to next year’s earnings estimate gives us a price target of $13.77, about 14% above current prices. Investors are also set to receive a dividend of $0.15 a quarter for an annualized yield of just under 5%.
That is an impressive yield from a stable, high-quality blue chip, but there is a way traders can more than double it.
Once you’ve mastered this strategy, I wouldn’t be surprised if you stopped trading stocks or buying and holding investments for years at a time. That’s how powerful it is. It can drastically improve the way you make money in the markets, and that goes for conservative income investors and aggressive traders alike.
How to Double Ford’s Yield With Entry-Level Options
The technique is actually pretty simple, but it will require some of you to leave your comfort zone. You see, it involves options, one of the most misunderstood corners of the financial world.
Many investors steer clear of options because they have a reputation for being risky, but that’s not always the case. Covered calls, one my favorite ways to generate a large income stream in addition to capital gains, can actually be more conservative than buy-and-hold investing.
Selling covered calls allows you to get paid up front for the opportunity to sell a stock you own at a higher price sometime in the future. Whether the stock goes up or down, you can come out ahead.
That’s not to say covered calls are risk-free — no investment is. But they can actually help reduce risk.
Here’s how it could work out with Ford.
To initiate a covered call, you first need to buy at least 100 shares of the stock, since each option contract you sell will control 100 shares. So, with Ford currently trading around $12.11, that would cost you about $1,211.
Once you own shares, you are eligible to sell covered calls on them. I recently recommended selling the F Dec 13 Call. That is a call option that expires in December with a strike price of $13. Those options are trading around $0.21 per share right now, so each option you sell would generate $21 in income.
This can be easily scaled up. If you owned 500 shares of F, for instance, you could sell five covered call contracts, which would rake in $105 in income instantly. This money is yours to keep, no matter what.
Selling this call means you will have to sell the stock at $13 if shares trade above that on Dec. 16 (the last day these options can be traded). In this case, you would make $0.89 in capital gains, plus the $0.21 for selling the call and the $0.15 October dividend. That gives you a total profit of $1.25 per share for a 10.5% gain on our cost basis of $11.90 ($12.11 stock purchase price minus $0.21 premium) in three months, or a 40%-plus annualized return.
Selling this call also means that if the shares fall, you are protected down to your cost basis of $11.90, which gives you a 1.7% cushion that regular shareholders do not have.
If F is trading for less than $13 on Dec. 16, traders will keep the $21 premium and their shares, and have the chance to sell more calls. If you were able to sell a covered call with a $0.21 premium every three months, you could earn an additional $0.84 per share. When you combine that with the regular annual dividend of $0.60, it boosts your yield to 11.9%.
Unfortunately, most investors don’t realize how large an opportunity this is. As a result, they’re settling for puny 1% or 2% annual yields from blue-chip stocks.
If you’re interested in earning double-digit yields instead, I’ve put together a special report called How to Pocket an Extra $3,000 a Month Using ‘Entry Level’ Options.
In it, I’ll explain how you can start using this strategy in your portfolio immediately and capture your first payment in as little as 48 hours. To get your hands on this report free of charge, simply go here.