Common stocks within the Dividend and Value Strategy will be issues of companies that pay a dividend and/or trade at a discount to overall market multiples (such as price/earnings, price/book value, enterprise value/earnings before interest and taxes “EBIT”). ETFs will be those whose strategies are clearly dividend or value related and whose fees are reasonable in the judgement of the advisor. Candidates also should exhibit consistent and/or growing dividends, revenue, net income, operating cash flow and free cash flow to be considered for inclusion within a client’s portfolio.
Common stocks are typically of mature companies that have a solid history of generating meaningful free cash flow which they return to shareholders through dividends and/or accretive share repurchases. Candidates will have strong balance sheets (limited leverage), leading market positions and tenured and proven senior management. Real Estate Investment Trusts (“REITS”) may be included as many have relatively high dividend yields easily covered by their funds from operations, avoid taxation at the entity level and may also have potential for stock price appreciation.
“Covered Call Income Strategy” – A method employed in the Dividend and Value Strategy to generate additional income is through opportunistic covered-call writing. Essentially, by selling a call contract against a position held in a portfolio, the purchaser of that option has the right to buy 100 shares that you own at the strike price, which at the time the option is sold will be above the market price. For illustrative purposes, say that on January 15th you own 100 shares of ABC Company which is trading at $42 and write (sell) a call option for $2 (proceeds of $200) that expires on April 15th (3 months) giving the purchaser the option to buy your 100 shares at 45. At expiration, there are two scenarios as described below:
- If on April 15th, the stock is trading below 45, the option will expire and be worthless and you will have earned $2 which is a 5% additional return ($2 profit divided by the $40 net cost of investment).
- If on April 15th the stock trades above $45, the owner of the call option would likely purchase your shares providing you with an effective sale price of $47 ($45 call price plus the $2 option proceeds) providing you with an 12.5% return ($5 divided by your net cost of $40) for three months!
In exchange for the premium paid by selling the option you have given away upside potential should the stock trade above the strike price ($45) plus the premium received ($2). If the stock ran to $50 you would have made $3 more if you hadn’t sold the call option.