By Robert Hauver

Are there any “bargain basement” high dividend stocks with strong financials, undervalued earnings growth, and future dividend growth? Surprisingly, British Petroleum, (BP), an energy stock that many investors dumped, after its Gulf oil spill debacle, looks like one of the best stocks to buy once again for these attributes.

Investors have been shunning Big Oil stocks for the past year, so this sub-industry group as a whole is down a bit over -1%. However, unlike two of its larger peers, Chevron, (CVX), and Exxon, (XOM), BP has actually been getting support from institutional buyers in the past few months. Technically speaking, BP is also in the upper region of oversold territory, with its RSI of 35.14:

A lot of this new support has to do with BP’s improving earnings and low valuations.  BP has logged strong EPS growth in its most recent fiscal year, and recent quarter. Surprisingly, BP’s sales growth over the past 5 years topped both Exxon and Chevron, and was just above industry averages.  Although BP is only projected to grow 6.36% in its next fiscal year, its very low P/E gives it an enticing PEG ratio:

Dividends: After the 2010 Gulf spill, BP needed to eliminate its $.84 quarterly dividend payout for the balance of 2010, but then reinstated in 2011, at 50% less, ($.42/quarter). In 2012, BP has been able to increase its quarterly dividends, for the first time since the spill, raising them over 14%, to $.48/share. BP has been a cash machine for a long time, and as it works through the Gulf settlement payouts, its cash flow will only get even better.

BP foresees future dividend increases, as it stated earlier in 2012: “With operating cash flow generated by BP in 2011 reaching some $22bn – over 60% higher than in 2010 – CEO Bob Dudley confirmed the company’s expectation that net cash flow in 2014, in a $100 oil price environment, would be around 50% higher than in 2011. Half of the additional cash is expected to be used for re-investment and half for other purposes including increased shareholder distributions. 2012 will be a year of increasing investment and milestones as we build on the foundations laid last year. As we move through 2013 and 2014, we expect financial momentum will build as we complete payments into the Gulf of Mexico Trust Fund, restore high-value production and bring new projects on stream.” (Source: BP website)

BP’s dividend yield is now above those of CVX and Exxon, and is also above industry averages:

Covered Calls: Many income investors have begun selling covered call options in order to increase their income from dividend paying stocks. This options trading strategy is an easy way to double, or even quadruple your dividends, depending on the stock.

If you already own the stock, you can then sell 1 call option contract for each 100 shares that you own. (One option contract corresponds to 100 shares of the underlying stock.)

If you don’t own the stock, here’s the sequence for selling covered calls on dividend stocks:

1. Buy the stock, in 100 share lots – example, buy 200 or 300, instead of 250 shares.

2. Sell 1 call option contract for each 100 shares that you own, at a strike price above the stock’s current share price. The further above the share price you sell, the less premium you’ll receive. The further out in time you sell, the more premium you’ll receive, which will lower your break-even. You receive this option $ within 3 days of selling, often even the same day.

3. Collect whatever quarterly dividends are due, as they pass their ex-dividend dates.

4. At expiration time, if the stock has risen above the strike price, your shares will be sold at the strike price, and you’ll also pocket the difference between the strike price and your cost per share.  If the stock isn’t above the strike price then, the call option will expire, leaving you with the initial call premium $ that you received, plus your dividends, as your profit.

These BP Oct. 2012 call options pay nearly 3 times the amount of BP’s 2 quarterly dividends during this 7-month period. This $45 Oct. 2012 call option also holds a potential assigned yield of 2.66% annualized, ($.65/share, the difference between the $45 strike price and BP’s $44.35 share price.)  The catch is that your BP shares will be sold/assigned at or near expiration time, if BP rises above the $45 strike price.

(You can find more details for this trade and over 30 other high options yields trades in our Covered Calls Table.)

Cash Secured Puts: If you’re still wary of BP’s gulf spill headline exposure, an alternative options trading strategy would be to sell cash secured put options, and literally “get paid now to wait”.

The BP OCT. $44.00 put option, which is below BP’s share price, would pay you $3.65/ share, ($365 per option contract). This gives you a lower break-even price, of $40.35.

High Options Yields: This put option pays out 3.8 times what BP’s dividends pay over the next 7 months. In addition, you’ll receive your options premium $ within 3 days of making the trade, often even the same day, so you’ll have the use of this $ now, instead of waiting for the quarterly dividends.  (Note: Put sellers don’t receive dividends.)

If BP is below $44.00 at or near the Oct. expiration, you’ll be sold/assigned 100 shares of BP, for every put contract that you sold.  However, your net cost will only be $40.35, ($44 strike price, minus the $3.65 put bid premium you received when you sold the put).

(You can find more info for this trade and over 30 other high yield Cash Secured Puts trades in our Cash Secured Puts Table.)

Financials: While they aren’t quite as impressive as some of Chevron’s and Exxon’s figures, BP’s financial metrics are all above industry averages, with the exception of its operating margin. Although BP’s Debt/Equity ratio is higher than CVX and XOM, BP has a very high Interest Coverage figure of 31.8:

Disclosure: Author is long shares of BP and XOM, and is short BP put options.