Berkshire Hathaway (BRK.B), headed by Warren Buffett, recently announced that the company had sold almost two-thirds of its stake in Johnson & Johnson (JNJ). J&J has been a favorite of dividend investors, having raised the dividend for 50 consecutive years.
So why did Buffett sell J&J? Almost certainly because he saw better options available. Along with the disclosure of the sale of J&J came the purchase of National Oilwell Varco (NOV) and Phillips 66 (PSX), as well as increased positions in Wells Fargo (WFC) and Bank of New York (BK). Buffett clearly sees more opportunity in oil and banks than he sees in J&J.
A look at the financials of J&J shows a stock which is by no means cheap. The TTM free cash flow of $12,657 million, or $4.55 per share, gives a P/FCF of 14.9. This isn't unreasonable, but it certainly isn't a value. The dividend yield is a solid 3.6%, and the vast history of dividend increases is reassuring. But if you're not a dividend growth investor I don't see much value in J&J at this price point. It may be wise to sell like Buffett did, and one way to make a profit while doing this is to sell call options.
A call option has three components: a strike price, a premium, and an expiration date. By selling a call option you are selling a buyer the right, but not the obligation, to buy shares of J&J from you at the strike price at any time on or before the expiration date. If the option is exercised you are required to sell your shares at the strike price.
This strategy is reasonable only if you would like to sell your shares of J&J. Selling calls on stocks that you don't want to part with could have disastrous consequences. Let's take a look at call options with an expiration date of Jan 2013:
|Strike Price||Premium||Annualized Return|
The stock is currently trading at $67.78. Let's say that you've decided that you would like to sell your shares for no less than $70 per share. You could simply enter a limit order and wait, or you could sell the Jan 2013 $70 call option. Doing this you receive a premium of $69 for each contract (options contracts are in blocks of 100 shares) and you are obligated to sell your shares if the option is exercised. The $69 premium is a 2.4% annualized return on the strike price. If the option is never exercised this strategy essentially increases your dividend yield from 3.6% to 6%, including the options premium which you receive. If the option is exercised you sell the stock at a price which you're happy with, receiving a nice premium in return.
Although imitating Buffett isn't always the best idea for the average investor, J&J at the current price level is not a value and there are certainly better options available in the market. By selling call options you can receive a premium for waiting for the stock to reach a level which you're comfortable selling, acting as a sort of dividend enhancer to an already high-yield stock. It is important that this strategy is only used if you truly want to sell the stock, as being forced to sell a stock which you would like to keep is not a pleasant experience.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.