Wednesday, August 13, 2014

A lesson on how to make money on a break even stock. TheMoneyMadam

The Income Investor Set Up.

Even the best income investors get caught in the income investor setup.   You analyze data and decide that a stock, a stock with a history of increasing the dividend about thirty three percent per year and a nearly 3% dividend yield is a good stock for you.  This stock has earnings that are much greater than their dividend payout and the D/E ratio is very acceptable.   You buy that stock.

Time goes by, you cash those dividend checks, you may even sell a covered call to boost that meager 3% dividend yield and you expect the dividend increases to continue.  

Now comes the bad news.   The expected dividend increase doesn’t happen.  Stock price is just barely above where you bought it and your yield is less than 3% now.   You find no covered calls to boost your income and provide the 10% capital gain you expect.   What should you do?  Would any event make you buy more or sell your position?

The Decision to Sell at Cost

The stock takes a tumble on bad news.   The price drop is not enough to make the dividend yield high enough that you might add to your position particularly since the dividend increases have stopped.  

The company is still safe.  Earnings exceed dividend and D/E is o.k. so your stock is not going to go out of business.  But you are an income investor and you need to find a stock with a 3.5% yield that has a better chance of maintaining dividend increases or you to need sell calls that boost your income but provide no capital gain.   You investment now is like a bond.  You get back your basis if they take your stock and you still have income if they do not.

I bet you think I am talking about INTC but I am talking about Packaging Company of America, symbol PKG.

I am just underwater on this stock that yields 2.92%.  I have enjoyed regular and increasing dividend income until the last quarter when the dividend did not increase.   I even scored one covered call but the fun is over.  The stock slumped on Wednesday and I sold an October covered call at my cost basis of $67.50.  The call premium income was $1.00.    If they take my stock the investment is like a bond.  I get back my principle and I got income too.   If I still own PKG in October, I will reassess what to do with the position.

The lesson is to look at positions that are break even and determine if you should sell calls at that basis and risk losing your stock just to pocket some income.   The choice is yours.