Doubling Your Dividend Aristocrat Yield, Take Two

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Includes: BCR, BEN, CLX, CTAS, DOV, ECL, ED, EMR, GPC, KO, XOM
by: Eli Inkrot

Summary

This article continues the “Doubling your Dividend Aristocrat yield” series, focusing on 12 new companies.

It’s possible to double the cash flow provided by these securities by agreeing to sell only with a gain of 7% to 21%.

In the end it’s about recognizing that this sort of option is available and determining what best suits your investing needs.

This is a the second article in a four part series covering the Dividend Aristocrats - companies that have not only paid but also increased their dividends for at least two and a half decades. A lot of income investors focus on these types of partnerships, but thereafter do not spend much time looking into further possibilities. The idea of this series is to demonstrate how you could potentially double the amount of cash flow that you receive from holding a Dividend Aristocrat company.

In the first part of this series, I highlighted the first 12 Dividend Aristocrats (alphabetically) along with some call options available at the time. This part continues that idea, focusing on the next 12 Dividend Aristocrats:

Company

2/1 Price

Ann Div

Strike

"Net" Prem

Cintas (NASDAQ:CTAS)*

$85.53

$1.05

$95

$1.75

Clorox (NYSE:CLX)

$129.68

$3.08

$140

$3.45

Coca-Cola (NYSE:KO)

$42.88

$1.32

$45

$1.24

Colgate-Palmolive (NYSE:CL)

$66.42

$1.52

$72.50

$1.74

Consolidated Edison (NYSE:ED)

$69.54

$2.68

$72.50

$2.40

CR Bard (NYSE:BCR)*

$184.89

$0.96

$200

$3.05

Dover (NYSE:DOV)*

$57.84

$1.68

$65

$1.50

Ecolab (NYSE:ECL)*

$107.15

$1.40

$120

$1.40

Emerson Electric (NYSE:EMR)

$45.36

$1.90

$50

$1.70

Exxon Mobil (NYSE:XOM)

$75.81

$2.92

$82.50

$3.05

Franklin Resources (NYSE:BEN)

$33.97

$0.72

$40

$1.15

Genuine Parts (NYSE:GPC)*

$82.29

$2.46

$85

$3.15

Click to enlarge

The first column shows the company name followed by a recent share price and annual dividend yield. The dividend is based on the current quarterly dividend payment, so naturally the actual amount you might receive could be higher as the companies increase their payments.

In looking for potential options I focused on the January 2017 expiration. I have no affinity for this date, but it makes annual comparisons relatively straightforward. There were five cases, denoted with asterisks, where these year later options were not available. In those cases I used options expiring between July and September of this year. This makes the annual assumption more cautious, but also makes those securities less comparable.

The strike price represents a price at which you might be willing to sell. These prices were picked because the option premiums offered were similar to the annual expected dividend yield. Note that I have deducted $0.25 from each premium bid to account for transaction costs and fluctuations.

With options you usually need to work in "round lots" of 100 shares and the option premiums may not taxed the same as qualified dividends.

To make the table clear, I'll work through an example. Let's say you owned 100 shares of Exxon Mobil. The market value of those shares would be about $7,600 and you might anticipate receiving $292 or more in annual dividends. You could continue to hold shares and do quite well. Alternatively, if you wanted a greater immediate cash flow, you could elect to agree to sell your shares.

At an $82.50 strike price, you would be agreeing to sell your shares for a total of $8,250. For making this agreement you would receive ~$300 upfront. If the option is not exercised, you keep the $300 premium, collect your dividend payments and continue to hold shares as you would. If the option were to be exercised, you would be forced to sell at $8,250, keep your premium and potentially collect some dividends along the way. In other words, either your cash flow is doubled or you would have a 13% to 17% annual gain.

Here's a look at the potential yields for the options of all 12 securities mentioned above:

Here you can see that the attractiveness of the available options varies somewhat dramatically. Moreover, there is always a secondary consideration involving only agreeing to sell at share prices that you would be happy with.

The dividend yield column shows the "current" yield based on the quarterly dividend and recent share price, just as you are accustomed to seeing. The "premium yield" column shows you the additional cash flow that could be generated by agreeing to sell at the strike price listed in the first table. The final column - max gain - tells you the "capped" gain that you are agreeing to with the strike price and the premium received. Note that you could also receive dividend payments, which would increase your overall return.

Let's think about these securities collectively. You wouldn't construct a portfolio this way, but imagine you owned 100 shares of each company. The value of those holdings would be about $98,100. Your expected dividend income would be about $2,200 plus any dividend increases along the way. You could hold these shares and likely do just fine over the long-term.

Yet let's imagine that you wanted to generate more than $2,200 in cash flow for the year (for any number of reasons). With the available options above you could agree to sell all of those stakes for a total of $106,750, or an 8.8% higher price. For making this agreement you would receive about ~$2,500 (less transaction fees and taxes) in upfront premium income.

Now one of a few things happens: all of the options go unexercised, some of the options are exercised or all of them are exercised. Let's look at the two extremes.

If none of the options are exercised you continue holding the shares just as you had planned on doing. You still own 100 shares each, still have the underlying earnings claim and still collect the (hopefully increasing) dividend payments along the way. The only difference is that you would also receive ~$2,500 upfront. In this scenario selling the covered call is clearly favorable.

If all of the options are exercised, you are forced to sell your shares at a price of $106,750. You still receive the upfront ~$2,500 premium, good for a return of about 11.4%. Should you also collect the dividend payments along the way (as would be the case if the options were exercised at the end of the period) your return would go up to about 13.6%.

So those are the basic outcomes of selling the above options. In the aggregate you would either double your cash flow yield or else agree to an 11% to 14% annual gain. Naturally some alternatives could appear more attractive than others, but the idea is to get an idea of what could be out there.

Selling covered calls do not prevent potential loss. However, if you're planning on holding anyway, both your downside and upside is potentially lower.

The main risk involved, assuming you're happy to own shares anyway, relates to capping your upside. Agreeing to sell Exxon Mobil at a 13% gain and then seeing shares jump 30% could be irksome. Yet it's not the difference between positive and negative, it's the difference between solid gains versus exceptional ones. The key is to be happy with either outcome.

In short I'm not suggesting that you should automatically (or ever for that matter) look to double your Dividend Aristocrat yield. Everyone has different investing goals. Instead, I merely want to provide a means by which you could expand your investing toolkit. If you're looking for greater cash flow, you're not limited to either picking "high yield" securities or immediately selling shares. By selling covered calls you could supplement your dividend cash flow by agreeing to potentially sell at a higher price.

Disclosure: I am/we are long KO, XOM.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.