The incredible rally from the March lows has been disrupted. After soaring a remarkable 60% from the March lows, the S&P has pulled back more than 8% from the high. The selloff was long overdue and frankly healthy. It couldn’t continue the torrid pace higher forever.
The recent pullback has put several high quality stocks back in the buy range. In this issue, I highlight one of the very best large companies on the market. The recent turbulence has caused a rare pullback in the price that presents a buying opportunity in a stock that is rarely ever cheap. It also generates substantial call premiums and fantastic income potential.
Cabot Income Advisor 920
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The Selloff Creates an Amazing Income Opportunity
The incredible rally from the March lows has been disrupted. After soaring a remarkable 60% from the March lows, the S&P has pulled back more than 8% from its early-September high. Where do we go from here?
Aside from the continuing Covid ordeal, the market is looking ahead to a possible contested election. The political rancor between the parties is getting even uglier after the death of Supreme Court justice Ruth Bader Ginsburg and Republican efforts to nominate a new judge. The toxic political environment makes an agreement on more stimulus much less likely.
That said, a market pullback was long overdue, and frankly healthy. It couldn’t continue the torrid pace higher forever. The market could still continue a longer-term uptrend. But the selling may not be over yet. These are crazy times, and headline risk will continue to be high.
The recent down market has decreased the level of call premiums in general and limits the opportunity in the near term. In the meantime, the existing portfolio positions all have secure dividends and can weather a further storm if the market turns south.
There are also lots of opportunities out there. The overall market may have run up high, driven by technology stocks, but many stocks and sectors still remain cheap. There are numerous stocks that will likely be priced a lot higher a year from now as the recovery inevitably gains traction.
The recent selloff has also put several well-performing stocks back in the buy range. In this issue, I highlight one of the very best large companies on the market. The recent turbulence has caused a rare pullback in the price, presenting a buying opportunity in a stock that generates substantial call premiums and opportunities for high income.
Monthly Recap
August 26
Purchase – Valero Energy (VLO) – 53.7
Purchase – Starbucks Corp. (SBUX) – 82.41
September 2
Sold SBUX October 16 87.50 call at $3.30 or higher
Sold BIP October 16 45 call at $1.95 or higher
September 18
Expired out-of-the-money - ABBV September 18 100 call at $4.60
Expired in-the-money - IIPR September 18 100 call at $5.00
Expired in-the-money - QCOM September 18 95 call at $4.30
Expired in-the-money - USB September 18 37.50 call at $2.00
Positions in IIPR, QCOM and USB have likely been called away. IIPR closed Friday (at expiration) at 124.79, with a strike price of 100. QCOM closed at 110.69 with a 95 strike price. And USB closed at 37.62 with a strike price of 37.50. ABBV, however, closed well below the 100 strike price and remains in the portfolio.
What to Do Now
There has been a lot of activity in the portfolio this past week. Four positions, including AABV, IIPR, QCOM and USB, had covered calls written on them with an options expiration date of last Friday, September 18. Three of those positions exceeded the strike price and were called away (IIPR, QCOM, and USB).
Although I mentioned this in the update last week, it’s worth reviewing the basis of this income strategy again.
When positions are called away because the price has risen beyond the strike price, it’s reasonable to question the covered call strategy. After all, you could have made more money by simply holding on to the stock and not writing a covered call.
While there may be some lost appreciation in up markets, the strategy of generating a double-digit annual income is a winner in the aggregate. Such returns beat the market’s average return over time, and certainly in sideways and down markets. Plus, it provides a regular paycheck and enables you to generate a substantial income from your investments.
In order to extract a high double-digit income in a low interest rate world, it is necessary to sacrifice capital appreciation potential for income. That’s the nature of the beast. In most cases, writing calls on these positions will result in a double-digit income return in a short amount of time. That’s not so bad.
It’s also worth noting that stock appreciation is unrealized until you actually sell the stock. Those gains can easily evaporate in a cranky market. You don’t get a better return until you take it. But call premiums and dividends collected are money in the bank.
We may even be able to buy back the same stocks that were called away again in the future, and do it all over again. As long as you keep ringing the register, you’ll be happy with the returns.
There are currently only two positions with outstanding calls. The recent downward-trending market has reduced the level of call premiums and it isn’t an ideal point in time to write more. But things can change quickly.
I will likely write a covered call on the new position highlighted below in the near future. Because of the lag time between when I write an issue and when you receive it, it’s tricky to target a call price in the monthly issue. It’s easier to target a price with a “Special Alert” notification. Be on the lookout for one in your email in the days and weeks ahead.
Featured Action
Visa (V)
Buy Visa (V)
Visa is a global payments technology company that provides a digital currency instead of cash and checks to individuals and businesses in more than 200 countries and over 160 currencies. It is the largest payment processor in the world. It processed over $9 trillion in 2019 and its systems can process 65,000 transactions per second
It’s natural to refer to Visa as a credit card company. But that isn’t really true because Visa doesn’t loan money. You can charge things with a Visa card instead of using a debit, but it is the sponsoring bank that loans the money, not Visa. It’s the banks’ problem if someone can’t pay. Visa simply collects a fee on any debit, credit or mobile transaction. It rings the register every time individuals and businesses all over the world make a digital transaction with its cards.
That’s a good place to be and a great business to be in because the global trend toward cashless transactions is undeniable and unstoppable. In fact, digital payments surpassed cash transactions on a global basis a few years ago. The trend will not reverse itself and may well accelerate going forward. Visa is in the idea position to benefit.
Let’s take a look at the performance of the stock while the world is trending cashless. Over the last 10 years V has returned 1,104% (with dividends reinvested), which is more than four times the return of 252% for the S&P 500 over the same period. A $10,000 investment in Visa 10 years ago would be worth over $120,000 today.
The company essentially has a license to print money. It’s obscene. Maybe it should be illegal. But it’s not perfect. Business suffers during a recession as the volume of transactions decreases. And Visa is taking it on the chin in this pandemic.
In the last reported quarter, transactions decreased 13% from last year’s quarter. The highly profitable cross-border transactions were down 37% as the world shut down. As a result, Visa’s net revenues plunged 17% and adjusted earnings per share declined 22% year-over-year.
As good as this company is, it’s not immune to recession. But that’s why it’s cheap. This is one of those stocks that is never, ever cheap except in bear markets and recession. But the U.S. and global economy will surely recover from one of the worst quarters ever. The recovery is already underway and gaining steam. And Visa is a direct and immediate beneficiary.
The truth is that the stock isn’t all that cheap. It’s still up for the calendar year. And it’s down just about 9% from the recent high. It was very quick to recover from the bear market and has recently hiccupped with the latest market selloff. Unless the market is in for more trouble, V will likely resume its trend higher. But, even if the market gets creamed, V will surely recover.
And there’s something else I like about this stock—it generates fat call premiums. Because the stock has been such a stellar performer, many investors are willing to be on the price going higher in the future. Also, because the dividend is modest, yielding just 0.61%, it gets much better call premiums that higher dividend-paying stocks. That makes it a great income opportunity. The stock is generating great call premiums even in this crummy market.
Visa is one of the very best large companies on the market to own. It’s about as close as you can get to a sure bet over time. This advisory will parlay that fact into a terrific income.
Visa (V)
Security type: Common stock
Industry: Financial
Price: $199
52-week range: $133.93 - $217.35
Yield: 0.62%
Profile: Visa is the largest payment processor in the world.
Positives
- The world continues to trend strongly toward cashless transactions.
- The U.S. and global economy are rapidly recovering.
- The stock has an amazing track record that should continue.
Risks
- Revenues and earnings are cyclical and the stock could take a hit if the economy falters.
- The payments processing field is becoming increasingly competitive.
Covered Calls
ABBV September 18 100 call at $4.60 – Expired
Total return: 6.3%
$1.18 dividend (Aug. 14)
$4.60 call premium
$5.78 total (income return of 6.3% in three and a half months)
IIPR September 18 100 call at $5.00 – Expired and called
Total return: 24.2%
$1.06 dividend (July 15)
$3.00 call premium
$5.00 call premium
$12.18 capital appreciation (strike price 100 minus 87.82 purchase price)
$21.24 total (return of 24.2% in three and a half months)
Portfolio Updates
AbbVie Inc. (ABBV)
Yield 5.2%
This stock survived the September 18th expiration round. It closed expiration day at a little over 90 per share with a strike price of 100. After a torrid run higher after the bottom in March, the stock ran out of gas in the middle of July. The calls were written near the peek. Despite the recent lackluster performance, I like ABBV right now. It sells at less than 11 times forward earnings. It has a defensive and growing business. And it is a stock and a sector that should hold up if the market continues to be volatile in the weeks and months ahead. BUY
Altria (MO)
Yield 8.6%
The stock’s performance amidst this latest market selloff has been disappointing. It actually took a bigger hit than the overall market. The company has resilient earnings and the stock price is already depressed. But MO got dunked anyway. It pulled back a little over 10%. Investors really do hate this stock. But the high dividend is rock solid. Altria just raised it 2.4%, marking the 55th hike in 51 years. Sure, JUUL has been a bummer, but that’s already reflected in the price. The market is underestimating the growth potential of heated tobacco product IQOS. The uptend since May has been disrupted but this is an ideal entry point for one of he best income stocks on the market. BUY
Brookfield Infrastructure Partners (BIP)
Yield 4.0%
This is a stock that the market fancies. Providing crucial services like utilities, energy infrastructure, transportation and cellular towers is just a good business. That’s why BIP has been trending higher since May, and it barely noticed the recent market downturn. It doesn’t look like the stock will dip below the 45 strike price for the call anytime soon (currently 47.28) and the stock is likely to be called away on the expiration date of October 16th. But that’s okay. BIP will provide a double digit return in a relatively short time if it’s called. BUY
Enterprise Product Partners (EPD)
Yield 10.7%
It’s another week and another five days of lousy performance for this hated stock. I’m at my wits end with this one. I assure you, that massive distribution yield is safe and will continue to be paid. As well, the business has been remarkably resilient through the pandemic and is recovering well before other energy companies. But the market doesn’t seem to care. And I’m beginning to fear that it never will. I said it before and I’ll say it again. EPD should be at the very least a great income stock. It should be more but we’ll see. We’ll collect the double digit income and, if it ever gets a move on, we’ll write a call. BUY
Starbucks Corp. (SBUX)
Yield 1.9%
This hipster coffee house stock is a wonderful addition to the portfolio. If you followed the recommendation, you likely got a huge premium for the calls with a strike price of 85 (currently 83.79). The stock wants to go higher and is just being held back by the market selloff. We’ll see what the market does in the next couple of weeks. If the stock rises higher and gets called away on October 16, we’ll lock in a sweet return in a short time. If it doesn’t get called, there will be opportunities to write more calls in the future. BUY
Valero Energy (VLO)
Yield 8.0%
This stock is not behaving well at all. It’s an odd situation. On the one hand, the market is factoring in a robust recovery in the quarters ahead. Such an occurrence will surely power earnings for Valero, as diesel and gasoline will fuel that very recovery. On the other hand, the market continue to shun a direct beneficiary of the recovery it anticipates. Something has to give. I will continue to hold this beleaguered stock for now. HOLD
Income 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 Income Advisor for an explanation of how dates are estimated.
The next Cabot Income Advisor issue will be published on October 28, 2020.
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President & Publisher: Ed Coburn
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