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Dividend Investor
Safe Income and Dividend Growth

Cabot Dividend Investor 718

In today’s letter, I’m adding a consumer staples stock to the Safe Income Tier, positioning the portfolio to take advantage of a possible rebound in the sector. If it doesn’t come to pass, we’ll still be happy to own the stock, a Dividend Aristocrat with near-perfect Dividend Safety and Growth scores.
Elsewhere, I’m selling half of a laggard in the Dividend Growth Tier, and have included earnings expectations for all of our stocks. And at the end of the issue, you’ll find a fresh explanation of a tried-and-true method for boosting your yield.

Cabot Dividend Investor 718

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Earnings Season Begins

Earnings season has begun. As usual, that means we’ll see larger-than-usual moves in stocks, many of which will turn out to be short term. Don’t overreact, stick to your plan, and be patient—do this and you’ll be fine.

Big picture, the stock market is healthy. Growth-oriented stocks like small caps and financials did well last week. However, some conservative sectors, like consumer staples, are starting to outperform, which helped lead us to this month’s new recommendation.

As for interest rates, the yield on the 10-year treasury has risen from 2.87% to 2.95% over the past week, and the odds of September and December rate hikes have risen slightly. The odds of the Fed raising rates a total of four times this year (two more than we’ve gotten) have risen to 61%, up from 46% a month ago. In other news, Trump criticized the Fed’s gradually rising rate hike path on Friday, breaking with a two-decade tradition of the White House respecting the central bank’s independence.

[highlight_box]What To Do Now: I’m selling half of BB&T (BBT) today, due to poor technical performance and a lack of support. I have no other changes, but include details on plenty of earnings reports in today’s issue. [/highlight_box]

Featured Buy

McCormick & Company (MKC)

As I wrote above, the market is trending up, and some conservative, counter-cyclical investments, like consumer staples stocks, are outperforming growth stocks. While growth-oriented investors may see this as a yellow flag, Cabot Dividend Investor has flexible investment goals and a portfolio that can accommodate many types of investments. That allows us to use these types of rotations to our advantage.

Today, I’m doing just that by adding a conservative Dividend Aristocrat from the consumer staples sector to the Safe Income tier. If consumer staples and other conservative stocks continue to do well, this company should be at the forefront of the move. If growth stocks retake the lead, we’ll still be happy to own the stock, which is a rock-solid long-term investment with an impeccable dividend history.

The Company
Maryland-based McCormick (MKC) was founded in 1889 and has grown to become one of the largest spice and flavoring companies in the world. In addition to their eponymous line of spices, McCormick makes condiments, stocks, oils, recipe mixes, salad dressings, baking ingredients and more. Consumer products make up about 62% of sales.

The remainder of sales are to food service and food and beverage companies, which buy commercial versions of the above products, as well as “custom flavor solutions” that flavor many of the packaged foods you eat, from chips to chocolates.

McCormick’s consumer brands include McCormick, Old Bay, Zatarain’s, Thai Kitchen, Club House and Lawry’s. Last year, McCormick added the French’s and Frank’s RedHot brands to its portfolio with the acquisition of Reckitt Benckiser’s food division, the largest acquisition in the company’s history.

McCormick is international, but the Americas are the company’s largest market, making up 68% of sales.
Selling spices is a steady business, and McCormick’s revenues have risen steadily in each of the past 10 years. EPS declined slightly in 2013 and 2015, but grew in every other year, often by double digits.

A major reason why I’m recommending MKC now is analysts’ strong estimates for the next few years. MKC is expected to report 17% earnings growth this year and 8% growth next year, supported by 13% and 3% revenue growth. Longer term, analysts expect EPS growth to average 11% per year over the next five years.

McCormick’s fiscal year starts in December, so the company already reported second-quarter earnings at the end of June. The company’s next earnings report will likely be released toward the end of September.

The Dividend
McCormick pays quarterly dividends, and currently yields 1.8%. The company has paid dividends since 1925, and has increased the dividend every year for 31 straight years. Over the past decade, McCormick has increased the dividend by an average of 9% per year, an impressive growth rate to sustain over such a long time. The company’s payout ratio based on EPS is currently 42%, which is just a little below its average (49% over the past five years).

With such a long and impressive dividend history, plus strong earnings estimates, it’s no wonder that MKC earns Dividend Safety and Growth Ratings of 10.0 and 9.0, respectively.

The Stock
MKC was in a strong uptrend until June 2016, when consumer staples stocks began a period of correction and consolidation that lasted for two years. MKC traded in a wide, sideways range until late last month, when the stock broke out to a new all-time high after reporting stellar second-quarter earnings. The stock followed through with several more days of gains, a sign of strength, and has been consolidating since.

Even after last month’s jump, the stock is still reasonably valued, with a P/E of 25 and a forward P/E ratio of 24.

If money continues to rotate into consumer staples stocks in the second half of the year, MKC’s breakout could mark the start of a strong new uptrend for the stock.

If, on the other hand, consumer staples remain under pressure, we could see a period of consolidation here instead. In that case, Safe Income investors might consider using covered calls to increase their yield. For example, right now you could sell covered calls expiring in September with a strike price of 125 for about $0.80, creating a yield of about 0.7% (equivalent to an annual yield of 4% or so.) If you’re comfortable holding longer-dated options (making it more likely that your stock will get called away from you), you can sell December calls with a strike price of 125 for about $2.70, creating an extra 2.3% in yield, or even March 2019 125 calls for $4.00, creating 3.4% in yield over about eight months.

For more on how to use covered calls to generate extra yield from stocks you already own, see the article at the end of this issue. Or, even better, come to this summer’s Cabot Wealth Summit, where I’ll teach you to use them in person, along with my colleague, Jacob Mintz, Chief Analyst of Cabot Options Trader. If you’re not registered yet, you can do so by clicking here.

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McCormick & Company (MKC)
Price: 117
52-week range: 92.93-120.23
Market cap: $15.38 billion
P/E: 19
Current yield: 1.8%
Annual dividend: $2.08
Most recent dividend: $0.52
Dividend Safety rating: 10.0
Dividend Growth rating: 9.0
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Dividends since: 1925
Consecutive years of increases: 31
Qualified dividends? Yes
Payment Schedule:
Quarterly
Next ex-dividend date:
October 5, 2018 est.

Portfolio at a Glance

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Portfolio Updates

High Yield Tier

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The investments in our High Yield tier have been chosen for their high current payouts. These ?investments will often be riskier or have less capital appreciation potential than those in our other ?two tiers, but they’re appropriate for investors who want to generate maximum income from their? portfolios right now.

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BUY – AllianceBernstein (AB 30 – yield 8.5%) – AB broke out to a new multi-year high a week ago and has kept running. The stock has been supported by a decent rally in financials, which coincided with a spike in Treasury yields. Among other factors, a selloff in Japanese bonds contributed to the move. AB will report second-quarter earnings tomorrow, July 26, before the open. Earnings estimates have come down a bit over the past few weeks and analysts are now expecting a slight decline in revenues, to $769 million from $802 million last year. EPS are still expected to rise 20%, to $0.59 per share from $0.49 last year. I’ll keep AB on Buy, although the earnings report introduces some short-term uncertainty. Also keep in mind that AB’s distributions are variable and don’t qualify for the lower dividend tax rate.

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BUY – Community Health Trust (CHCT 30 – yield 5.3%) – CHCT also broke out to a new 52-week high this week, bucking the trend in the healthcare REIT space. REITs are typically negatively correlated to interest rates, so investors may be anticipating strong numbers when CHCT reports earnings August 7, after the close. Analysts are currently expecting to see 37% revenue growth, to $12.2 million, and EBITDA growth of 13%, to $8.8 million. The stock is in a steady uptrend and is buyable right here for risk-tolerant investors looking to add yield to their portfolio.

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HOLD – General Motors (GM 39 – yield 3.9%) – GM reported second-quarter earnings before the market opened today, and the stock didn’t like them. EPS and revenues beat expectations, but management lowered their full-year earnings guidance from $6.41 to $6.00 per share. Management cited higher commodity costs, which they expect to continue all year, and the changing value of the Argentine peso and Brazilian real. Management will hold a conference call at 10 a.m. Eastern, at which point they will provide more details. For now, we’ll Hold.

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BUY – ONEOK (OKE 70 – yield 4.5%) – ONEOK will report second-quarter earnings after the close this coming Tuesday, July 31, and hold the earnings call the next day. Analysts are currently expecting the company to report 31% revenue growth to $3.57 billion, from $2.73 billion, while EPS are expected to more than double, to $0.67 from $0.33. The stock is trading just under 52-week highs, and the energy sector remains stable. Note that although ONEOK owns pipelines (as well as natural gas storage and processing facilities) it’s not a master limited partnership (or MLP). The company is organized as a corporation and dividends qualify for the lower dividend tax rate. High-yield investors can Buy here.

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BUY – STAG Industrial (STAG 27 – yield 5.3%) – STAG’s pullback continues, and the stock met up with its 50-day line yesterday. So far the pullback looks normal. STAG, an industrial REIT, will report second-quarter 2018 results on July 31, after the close. Analysts are looking for revenue of $71.7 million, up 16% from last year. EBITDA is expected to hit $59.0 million, 13% higher than in second-quarter 2017. High-yield, risk-tolerant investors can use this pullback to start a position in STAG.

Dividend Growth Tier

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To be chosen for the Dividend Growth tier, investments must have a strong history of dividend increases and indicate both good potential for and high prioritization of continued dividend growth.

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BUY – American Express (AXP 102 – yield 1.4%) – American Express reported earnings last Wednesday. The stock pulled back briefly following the announcement, but bounced off its 50-day line and is now rebounding. EPS beat estimates by two cents and were up 25% year-over-year, thanks in part to a big drop in Amex’s tax rate, from 31% to 22%. Revenues of $10 billion rose 9% year-over-year, thanks to 10% growth in card-member spending, although the number missed analysts’ estimates by a hair. Management also reaffirmed their guidance for the rest of the year. AXP still looks healthy and I’ll keep it on Buy for steady dividends and growth.

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SELL HALF – BB&T Corp (BBT 51 – yield 2.9%) – BBT fell to a new six-month low after reporting second-quarter earnings last week. Thanks in part to the big tax break, adjusted EPS rose 31%, to $1.01 per share, which was in line with analysts’ estimates. Revenue was flat year-over-year, but also in line with estimates. Most organizational metrics improved, including average deposits, return on equity, loan growth and charge-offs. At the same time, BBT increased its dividend by 8%, to $0.405 per share per quarter. However, the stock sliced through its 200-day line, on high volume, and fell further the next day. BBT has begun rebounding, but there are some big red flags here: a) support at recent lows didn’t hold, b) other financial stocks are doing much better, and c) the stock has now been mostly below its 200-day line since for a month. Given these concerns, I’m going to reduce our risk today by selling half our shares.

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BUY – Broadridge Financial Solutions (BR 118 – yield 1.2%) – BR continues to behave well, trending up gradually just above its 50-day line. The stock is facing some overhead resistance at 120, but I’m not worried yet. Broadridge will report fourth-quarter and full-year results before the open on August 7 (the company’s fiscal year ends in June). Analysts are expecting fourth-quarter revenues to fall slightly (about 2%), to $1.32 billion, but EPS are expected to jump from 1.71 to 1.87, about 9%. For the full year, EPS are expected to rise 34%, to 4.20 per share, while revenues are expected to rise 4%, to $4.33 billion. Investors looking for steady capital gains and dividend growth can Buy BR right here.

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HOLD – CME Group (CME 168 – yield 1.7%) – CME will report second-quarter earnings before the open tomorrow, July 26. Analysts are currently predicting that EPS will hit 1.72, up from 1.23 last year (40% growth), thanks in part to changes in the tax code. Revenues are expected to rise 13.5%, from $925 million to $1.05 billion. The stock looks okay, bouncing back and forth around its 50-day moving average, but faces overhead resistance around 171. Hold.

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HOLD – Intel (INTC 52 – yield 2.3%) – Intel’s recovery continues; the stock has made it almost all the way back to its 50-day moving average, and continues to trade above its 200-day line. The company will report earnings after the close tomorrow, July 26. Analysts are now expecting 33% EPS growth, to $0.96 per share from $0.72 last year, and 14% revenue growth, to $16.8 billion from $14.8 billion. Intel is still on probation—in addition to the CEO’s unexpected resignation the company is also facing increasing competition and some analysts are predicting a downturn in semiconductor stocks—but for now we’ll hold.

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BUY – Occidental Petroleum (OXY 83 – yield 3.7%) – Occidental will report second-quarter results after the close August 8, with an earnings call the next day. Analysts’ expectations are high: 18% revenue growth, to $4.24 billion, and a ridiculous 700% increase in EPS, from 0.15 to 1.21. Reuters reported yesterday that Occidental is looking to sell some pipeline assets to invest more in exploration and production. OXY remains near the bottom of its trading range, and below its 50-day line. I’ll keep the stock on Buy for now, although you may want to keep positions smaller than usual until after earnings.

Safe Income Tier

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The Safe Income tier of our portfolio holds long-term positions in high-quality stocks and other investments that generate steady income with minimal volatility and low risk. These positions are appropriate for all investors, but are meant to be held for the long term, primarily for income—don’t buy these thinking you’ll double your money in a year.

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HOLD – Consolidated Edison (ED 78 – yield 3.7%) – ED continues to trade choppily between its 50- and 200-day lines. The utility will report second-quarter earnings August 2, after the close. Analysts are expecting EPS of $0.56, down 3.4% from $0.58, and revenue of $2.66 billion, up just 1% from $2.63 billion. ED isn’t a fast grower, but the dividend is as stable as the come. The stock will probably chop around some more short-term, but it remains a solid long-term Hold for safe income.

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BUY – Invesco BulletShares 2019 Corporate Bond ETF (BSCJ 21 – yield 1.4%)
BUY – Invesco BulletShares 2020 High Yield Corporate Bond ETF (BSJK 24 – yield 4.8%)
BUY – Invesco BulletShares 2021 Corporate Bond ETF (BSCL 21 – yield 2.4%)
BUY – Invesco BulletShares 2022 High Yield Bond ETF (BSJM 25 – yield 5.3%)
The BulletShares funds make up our bond ladder, which is a conservative strategy for generating a steady income stream by buying a series of individual bonds or defined-maturity bond funds that mature in successive years. Because the BulletShares funds are short term and mature at the end of the year in their name (at which point Invesco disburses the net asset value, or NAV, of the ETF back to investors), they are a good store of value even when interest rates rise. And if you reinvest the proceeds of the maturing fund in a new, longer-dated holding every year, you can secure rising income stream as rates rise. You can construct your own ladder with either the investment-grade or high-yield funds, or a mix, as we’ve done. Invesco is also introducing a new series of BulletShares funds that hold municipal bonds, which may be of interest to some investors.

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HOLD – Ecolab (ECL 144 – yield 1.2%) – After reaching its 50-day moving average last week, ECL has pulled back once more and is now floating between its 50- and 200-day lines. Ecolab will report second-quarter earnings this Tuesday, July 31, before the open. Analysts are currently expecting EPS to hit $1.27, up 12.4% from $1.13 in second-quarter 2017, while revenues are expected to rise to $3.7 billion, a 6.7% gain from last year. Ecolab is a Dividend Aristocrat and a solid holding for long-term income investors. The company makes chemicals and cleaning products widely used in the industrial, healthcare and hospitality industries.

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BUY – Invesco Preferred ETF (PGX 15 – yield 5.7%) – PGX is an ETF that holds preferred shares and pays monthly distributions. The fund has low volatility but no capital appreciation potential; it generally trades between 14 and 16, depending on the direction of interest rates. Buy under 15 for a good store of value and regular income.

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HOLD – McGrath RentCorp (MGRC 62 – yield 2.2%) – MGRC remains below its 50-day line, though it has leveled out a bit. I’ll keep MGRC on Hold at least until after earnings, out July 31, after the close. Analysts are currently expecting a big EPS bump of 33.3%, from $0.48 to $0.64, thanks in part to MGRC’s new lower tax rate. Revenues are expected to rise by about 2.8%, to $112.7 million. McGrath has beat earnings estimates by more than 20% in each of the last four quarters, and gapped up following its last earnings report.

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BUY – UnitedHealth Group (UNH 254 – yield 1.4%) – UNH has been behaving nicely over the past week. The stock fell to its 50-day line after reporting second-quarter results last Tuesday, but found support quickly and has stayed above the 50-day. I’ll keep UNH on Buy for Safe Income.


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HOLD – Xcel Energy (XEL 46 – yield 3.2%) – XEL will report second-quarter earnings tomorrow, July 26, before the open. Analysts are expecting EPS of $0.47, up from $0.45 last year (4.4%) and revenues of $2.64 billion, down just 0.2%. The stock is choppy, but remains a decent long-term Hold for Safe Income.

Closing Prices on July 24, 2018

Dividend Calendar

Ex-Dividend Dates are in RED and italics. Dividend Payments Dates are in GREEN. Confirmed dates are in bold, all other dates are estimated. See the Guide to Cabot Dividend Investor for an explanation of how dates estimated.

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Increase Your Yield with Covered Calls

At the end of today’s recommendation of McCormick I mentioned that investors interested in juicing their yield from the stock might want to look into writing covered calls. When you write (or sell) a covered call on a stock, you offer to let someone else (your counterparty) buy the stock at a specific, higher price sometime in the future. They pay you for that right, which can be a nice way to generate steady income from stocks you already own. Of course, if the stock hits the price you agreed to sell it at (the strike price), you’ll have to sell it. But if it stays below the strike price, you get to keep the price your counterparty paid for the call (called the premium) and the stock.

My colleague Jacob Mintz, Chief Analyst of Cabot Options Trader and Cabot Options Trader Pro, regularly sends subscribers covered call ideas that they can use to generate yield in their own portfolios. In late June, he sent subscribers this idea:

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In this example, Jacob is suggesting selling a call on General Motors (GM), a stock in the Cabot Dividend Investor portfolio, to create additional yield. At the time, the stock was trading around 42.25. The call he’s looking at has a strike price of 43 and expires in August. (Monthly options expire on the third Friday of the expiration month, so this trade will expire August 17.) The calls were selling for a premium of $1.50. Call options are written on 100 shares at a time, so for each call you sell you’ll earn $150.

Jacob has done the math on the potential outcomes of this trade above.

His first calculation is the Static Return. This is your return on the trade if GM doesn’t move. In this scenario, you get to keep the stock and the $1.50 per share in premium. In this case you’ve effectively created a yield of 3.68% in two months (1.50/40.75).

If GM does hit your strike price, you have to sell the stock to your counterparty, but you make $0.75 per share on the trade, plus you get to keep the $1.50 per share premium. In this case your return is (0.75 + 1.50)/40.75, or 5.5%. Jacob calls this the Covered Call Return (if assigned).

Finally, Jacob also includes the Breakeven price for the trade. This addresses the worst-case scenario outcome, which is a decline in GM stock after you sell the call. However, since you sold the call for $150, you’ve created a little bit of a cushion before you start to lose money. Jacob’s Breakeven price tells you how much of a cushion you’ve created—in this case the stock can now decline to 40.75 (that’s 42.25 – 1.50) without you losing a penny.

A Few Things To Keep In Mind
Hopefully you now see that covered calls are a surprisingly simple way to generate extra income from stocks you already own.

Before you start selling covered calls on every stock in your portfolio though, there are a few things you should keep in mind.

First, remember that each call gives the owner the right to buy 100 shares of that stock (and the premium is multiplied by 100), so you can only write (writing is another word for selling) a call if you own at least 100 shares of a stock.

Second, very volatile stocks or stocks in strong uptrends are more likely to hit the strike price you pick, so keep that in mind. Of course, that means you’ll get paid more for selling the call, since it has a better chance of paying off for the buyer. Calls on stocks in sideways trends will pay less but carry less risk of you having to sell the stock.

Time also affects how likely your call is to expire worthless. GM isn’t that likely to move up 20% over the next month, but over the next six months it’s a pretty reasonable possibility. So you’ll get paid more for selling longer-dated calls.

Finally, if you find all this intriguing but are still a little wary, you should really come to this year’s Cabot Wealth Summit, happening in just a few weeks. Jacob and I will be going into even more depth on covered call strategies, and sharing a bunch of our best trade ideas. Just go to our website to learn more.

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