I encourage you to read this article that offered a detailed analysis on a 50/50 strategy for dividend investing. The article focused on the benefits of devoting 50% of your desired investment in a particular company, to purchasing the common shares outright. The remaining 50% of your desired investment, would be used to sell longer-term put options, through which you as the investor would generate additional income while having a strategy in place to capitalize on a market correction. It might surprise you that one of the most well known companies in the world perfectly fits the criteria for this type of trade. Employing the strategy detailed above, investors could structure a trade designed to yield over 5% annually through an investment in Apple. The investment is designed to allow investors to participate in principal appreciation, hedge against a market correction and general uncertainty surrounding the growth outlook for Apple (AAPL), and most importantly generate a substantial income opportunity from a structurally sound company that has recently committed to repurchasing massive amounts of its own stock which should limit the downside risk for the common stock.
Turning Apple Into An Investment That Yields 5% Annually
This is probably not a name you would expect to find with the potential to generate an annual income stream at the equivalent of greater than a 5% yield. Apple currently trades for about $441 a share, which is over 37% below its 52-week high:
AAPL data by YCharts
It is almost not worth mentioning the 52-week high for Apple because the outlook has changed drastically for the company since it hit those levels. For that reason, it is more relevant to discuss the 52-week low shown in the price chart above, which was right around $385 a share. The stock reached that level around the same time it reported its Q2 2013 earnings in late April. Since that time, the stock has moved as high as 20% above its 52-week low set in April.
It is hard not to argue that the combination of a changing perception around future growth rates, pressure on gross margins, increased competition, and the general removal of the Apple can do no wrong mentality has lowered the future upside potential for Apple in the near term. At the same time, Apple still sits squarely in value territory from a price to earnings "P/E" multiple standpoint. Apple currently trades at a P/E multiple of slightly over 11x the consensus earnings estimate from the analyst community for 2013. This is important, as part of the thesis in this type of investment strategy is being cognizant of the downside risk for the stock. Generating a 5% yield from this investment would not sound so hot if Apple had significant downside right from its current levels. While that may seem like common sense, not all dividend stocks are created equal, with the upside/downside potential for each stock dependent on any number of factors. In the case of Apple, the catalysts that will support the stock in the short term include:
- Upcoming product announcements and even rumors of future product announcements
- The $60B share buyback announced during the Q2 2013 earnings release (to be completed by 2015)
- The ~$145B of cash/cash equivalents on the balance sheet
- The 15% increase of the annual dividend, announced during the Q2 2013 earnings release, to $12.20 per share yielding about 2.80% on an annual basis with the stock trading slightly over $440
With that being said, the question many might ask is why not just buy the stock outright as it certainly appears to be undervalued. The answer is twofold. First, there is the chance that no matter how undervalued Apple may be, the broader market enters a correction period taking Apple down with it. Second, there is the chance that no matter how strong the compensating factors and catalysts noted above may be, concerns continue to linger about the risks facing Apple's business, which causes the stock to stagnate or depresses the stock price mildly.
That is how we come full circle to investing in Apple in a way that could take a stock that yields less than 2.8% today, and turn it into an Apple-centric investment with a 5% yield, which is 75% higher than the amount you would receive from just owning Apple common stock.
The proposed investment, using round numbers, would be to invest $80,000 in Apple with half being used to purchase the common stock and the other half of the investment covering the sale of an Apple put option. Briefly, by selling a put option, you as the investor are collecting the premium (think of it as income) and committing to buy additional Apple stock at a set price and time in the future. This strategy does not involve margin, or investing more than the cash you have on hand. 50% of your investment would be cash used to buy Apple stock, and the remaining 50% of your cash would sit in your brokerage account to cover the cost of purchasing additional Apple stock if the put option expired and the stock was below the strike price.
This investment would involve selling the April 2014 $400 Apple put option. Currently, the price for this option is ~$29. In selling this option, you would collect $2,900 (1 contract = 100 shares: 100 x $29 = $2,900). You are committing to purchase $40,000 worth of Apple shares if the stock price were to fall below $400.
The reason I prefer this investment to outright buying Apple stock, is because it is both an income strategy, a hedge against a falling stock price, and allows you to capitalize if Apple stock does materially move higher. The table below provides the structure of the trade, and how it is set up to earn a 5% yield in the next year:
Here is a simple way to think about the investment strategy laid out above. If Apple stock does not move for the next 12 months (or the time it takes to earn 4 quarterly dividend payments), an investor will collect over $4,000 on an $80,000 investment generating the 5% yield. The annualized yield would be slightly higher than 5%, as the $40,000 investment in the put options has less than a 12-month time period associated with it.
In summary, this investment strategy offers the following highlights:
- Designed to generate a greater than 5% annual yield/income stream from Apple compared to the 2.8% that owning the common stock would pay
- 50% of the investment involves owning the stock outright, which allows for the participation in whatever upside is seen from the Apple stock over the next year
- 50% of the investment pays you a yield of 7.3% and gives you the right to purchase shares of Apple at $400 should the stock fall below that level. This portion of your investment is also protected against close to a 10% drop in the price of Apple stock over the next year
The negative to this investment strategy is that your upside is less than it would be if you were otherwise to commit 100% of your investment to purchasing common stock, and Apple was to move higher. If you have that sort of conviction in Apple, then this is not the investment strategy for you. On the other hand, if you are focused on generating income, this is a relatively simple way to increase the annual yield from Apple by 75% while also protecting your total investment in a way you would not if you were to be fully invested in the common stock only.