In Search Of Great Dividends: Trading DuPont Options

| About: E. I. (DD)

By Mark Bern, CPA CFA

E. I. du Pont de Nemours and Company (NYSE:DD), typically referred to simply as DuPont, is the oldest company in the Fortune 500. It is a conglomerate engaged in a number of different areas such as biotechnology, electronics, high performance materials, safety and security, and, of course, chemicals. DuPont manufactures and distributes a broad array of products on a global scale. It serves many different industries including agriculture, automotive, apparel (protective), construction, electronics, and medical.

Third quarter results came in far better than expected, with earnings per share (NYSEARCA:EPS) surging 73 percent from the same period in 2010. Much of that increase was due to an early planting season in South America, which drew forward some sales that were expected to occur during the fourth quarter. As such, I caution readers to expect DuPont to disappoint when this quarter’s results are reported. However, if the street can look past the quarterly results and focus on the full-year, I expect that overall 2011 was a very good year for the company and shareholders.

DuPont is very well positioned to benefit from long-term trends in population growth and the surging number of people entering the middle class around the world, especially in emerging markets. First off, we all have to eat, and DuPont’s Pioneer Seeds is a recognized world leader that is growing along with the global demand for more corn and soybeans. The company’s agriculture business sales were up 41 percent over the prior year period in the third quarter.

The performance coatings division is benefiting from a growing demand for industrial and motor vehicle coatings. Growth in the auto industry in emerging markets is driving significant gains and I expect that trend to continue through the next decade. The rest of the business segments are doing well and positioned to take advantage of emerging market growth as well. The company derives about 64 percent of its revenue from outside the U.S.

Dividends are another bright spot for DuPont, with the current yield sitting at 3.6 percent. I do not expect a lot of growth in the dividend going forward -- perhaps a two percent average annual increase over the next five years with actual increases coming sporadically.

But the current yield is better than many alternatives, and is coupled with what I believe to be much more significant appreciation potential. I expect earnings to grow at an average annual rate of 12 percent or more over the next five years. Total return could reach an average of 18 percent per year during that time. That spells a double while collecting those great dividends!

But don’t forget my caution for fourth-quarter results. I should also add that with the global economy still in a weakened condition, there may be an opportunity to pick up shares a bit cheaper than the current quote of around $46 a share. My preference is sell a put option below the market, collect the premium and hope for the contract to be exercised. But that’s just my alternative method for placing limit orders. I like to get paid while I wait for the fill. If I don’t get the stock I just repeat the action, collecting the premiums along the way.

Currently, my favorite put option is the July 2012 $42 strike put option contract with a premium of $2.72. I would sell the option and collect the premium of $272 per contract (one contract = 100 shares) less a commission (usually discount brokers charge less than $10 per transaction) of $9 and net $263 now. Then I wait for the contract to be exercised, in which case, as seller I am committed to buy the shares at the strike price. If that happens, I get to buy 100 shares of DuPont at $42, and my cost basis is actually $39.28 ($42 minus the premium received of $2.72 = $39.28). Then my dividend yield would be 4.2 percent.

I only bring this method up here because I believe there is a chance that we could see a market slide in early 2012 that may get us that price. If I am wrong, the option expires worthless and we have garnered a return of 5.7 percent over seven months or 9.8 percent annualized. Not a bad return on cash these days.

Another alternative, should the price not drop, is to buy back the option at a much lower premium sometime during the spring (if the price remains stable over that time the option premium could drop well below $1 by April) and then buy the stock outright. Of course, there are other variations, but I don’t want to complicate things here.

Naturally, an investor could just buy the stock and hold it for a good long-term compound return.

Finally, let me remind readers that it is always best to do some further research to ensure that the stocks you read about are appropriate for your needs and goals for your portfolio. I always try to remind readers that any article they read on the Internet is a good starting point that should be followed by further due diligence. Successful investing to all!

Disclosure: I am considering selling put options on DD, as described in the article, for my own portfolio.

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