In a recent article ("5 Interesting Plays With Yields As High As 16%"), Seeking Alpha contributor Sol Palha reviewed a diverse handful of dividend paying names. In this post, we'll look at the VectorVest Dividend Safety scores, and the hedging costs, for all five names. With respect to Dividend Safety, VectorVest defines it as,
An indicator of the assurance that regular cash dividends will be declared and paid at current or at higher rates for the foreseeable future.
VectorVest ranks Dividend Safety on a scale of 0-99, where 0 is the worst possible score and 99 is the best (scores between 50 and 74 are considered good, and scores of 75 and above are considered excellent). To see VectorVest's Dividend Safety analysis for any dividend-paying stock, you can enter its symbol and your email address on VectorVest's homepage, and VectorVest will email you its analysis of the stock.
It turned out that one of these names had a Dividend Safety score of 0, and two others had scores above zero but still in the "poor" range. Two others, though, had scores in the "excellent" range: Telefonica SA (TEF) and Praxair, Inc. (PX). I've included updated yields and Dividend Safety scores for all five names in the table below, along with the current costs of hedging them against greater-than-20% declines over the next several months, using optimal puts.
For comparison purposes, I've added the iShares iBoxx Corporate Bond ETF (HYG) and the SPDR S&P Dividend ETF (SDY) to the table below. First, a reminder about what optimal puts are, and an explanation of the 20% decline threshold; then, a screen capture showing the optimal puts to hedge one of the names below, Kinder Morgan Energy Partners (KMP).
About Optimal Puts
Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones.
In this context, "threshold" refers to the maximum decline you are willing to risk in the value of your position in a security. You can enter any percentage you like for a decline threshold when scanning for optimal puts (the higher the percentage though, the greater the chance you will find optimal puts for your position). I have used 20% thresholds for all of the names below.
The Optimal Puts for KMP
Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of KMP against a greater-than-20% drop between now and September 21st. A note about these optimal put options and their cost: to be conservative, Portfolio Armor calculated the cost based on the ask price of the optimal puts. In practice, an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask (the same is true for the rest of the names below).
Hedging Costs as of Thursday's Close
The hedging data in the table below is as of Thursday's close, and is presented as percentages of position values. The yields and Dividend Safety ratings are as of Thursday's close as well. Bear in mind that the yields below are annualized, but the hedging costs below aren't.
|Div. Yield||Div. Safety|
|KMP||Kinder Morgan Energy||5.19%||0||1.67%***|
|TWO||Two Harbors Invest. Corp.||16.1%||32||5.00%***|
|HYG||iShares iBoxx HY Corp Bond||7.33%||58||1.27%***|
|SDY||SPDR S&P Dividend||3.13%||58||1.78%*|
*Based on optimal puts expiring in July
**Based on optimal puts expiring in August
***Based on optimal puts expiring in September