By Robert Hauver
Although the market has had a large rally over the past few months, the Dow 30 still lags the NASDAQ significantly in 2012, (the DOW is only up 6.78% YTD vs. NASDAQ’s 17.59% gain as of 3/22/12), This led us to look for undervalued Dow dividend stocks with low PEG ratios, and strong earnings. Our search produced these two familiar stocks, Boeing, and Microsoft:
Boeing has gained nearly 7% in 2012, (there’s a Performance table at the end of this article), but it’s still only up less than 3% over the past 12 months. Meanwhile, BA has grown its earnings substantially, so that it now has a much lower P/E than its industry peers.
With its strong growth forecast for its next fiscal year, BA has the second lowest PEG ratio of all the Dow 30 stocks. Although BA has a very high Price/Book, this is partially explained by its very high Return On Equity, (ROE), of 127.72%. (See Financials table further on in article.)
After being range-bound within the $20’s for around two years, Microsoft has risen into the low $30’s. However, it still looks fairly cheap on a PEG basis, coming in at .97. Even though its earnings and sales growth trail its industry averages, MSFT is one of the few dividend paying stocks within its industry, and offers a fairly good dividend yield, and a very good dividend growth rate.
Dividends: MSFT increased its quarterly dividend by 25% in 2011, from $.16 to $.20/share. Boeing increased its quarterly dividend in Feb. 2012, to $.44/share from $.42/share. Both stocks have a conservative dividend payout ratio:
Covered Calls: Income investors wanting to hedge their bets often sell covered call options, creating additional immediate income by receiving call options premiums, and thereby lowering their break-even cost.
As the table below illustrates, in these 2 covered call trades, the call options pay you 3 to 6 times what the dividends pay during the 4-5 month period. What’s the catch? By selling a call option, you’re obligated to potentially have to sell the shares at the call strike price by expiration time. (Generally, your shares will get assigned/sold if the stock goes above the strike price at or near expiration.)
There are 2 strategies in the trades listed below – the BA call has a higher strike price than BA’s share price, which gives you some room for potential price gains- (BA $75 .00 strike price is $1.08 above BA’s $73.92 share price). Conversely, the MSFT call strike price is right “at the money”, meaning the $32.00 strike price equals MSFT’s $32.00 share price. This leaves no room for potential price gain, but gives you a higher call option premium.
More bullish covered call sellers sell at higher strike prices, earning a lower call premium, whereas less bullish call sellers would sell calls with strike prices that are closer to the share price, and would get paid a higher call premium.
(You can see additional details for this and over 30 other high options yields trades in our Covered Calls Table.)
Cash Secured Puts: An alternative option trading strategy is to sell cash secured puts, which obligate you to potentially have to buy the stock at the strike price, if the stock goes below the strike at or near expiration. Generally, call and put options don’t get assigned until sometime near the expiration date, since call and put buyers don’t want to forfeit too much of the options’ time value.
Why would you sell cash secured put options? If you want to buy a stock at a lower price than its current price, the put premium $ that you receive lowers your break-even cost, so that, even though you may end up being assigned/sold BA at the $72.50 strike price, your net cost is only $68.70, the difference between the $72.50 strike price and the $3.80 put premium you received. Meanwhile, you have the use of that put premium $.
Investors are often surprised to hear that Warren Buffett has been known to sell put options, via private off-market deals, on companies he’s interested in buying, sometimes pocketing millions in put premiums now on expiration dates that go out a few years – it’s a very good cash flow deal.
These put options pay out 4 to over 7 times what the dividends pay out during this 4-5 month term. (You can see more details on these and over 30 other high yield Cash Secured Puts trades in our Cash Secured Puts Table.)
Financials: BA and MSFT both have mgt. efficiency ratios that far outshine their industry averages. BA’s debt load is higher than avg., but their interest coverage is very strong, but not as high as MSFT’s very high interest coverage of 77. BA’s ROE of 127.72% is currently the highest of any stock in the Industrials sector.
Performance: Although MSFT has been one of the best stocks to buy in 2012 for price gains so far, it’s still has a moderate Relative Strength of 55.55. With its RSI of 43.33, BA is closer to the sub-40 oversold area:
Disclosure: Author holds no shares of any stocks mentioned in this article at this time, but may sell cash secured puts during future market pullbacks.
Disclaimer: This article is written for informational purposes only and isn’t intended as investment advice.
Author: Robert Hauver © 2012 Demar Marketing All Rights Reserved