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A Covered Call Trade on Microsoft

Investor sentiment turned strongly bearish recently as emerging markets were hit by both country-specific problems and the realization that the Fed’s trimmed bond-buying program reduces the liquidity that has boosted higher-yielding emerging market assets and put a floor under U.S. stock prices.

The broad selloff in emerging markets over the recent weeks translated into the worst week for global stocks in seven months. The S&P 500 slid 2.6 percent, its largest weekly decline since June 2012.  Still, the S&P 500 is just 3.1 percent below its record closing high.  If the bears stay put, then the market could pull back over the coming months.

Due to the selling on Wall Street, investors were willing to pay more for spot protection against a drop in the S&P 500.  At this time, investors are concerned a market pullback may be overdue.

Investors should consider looking at blue chip stocks with low betas, nice dividend yields and sell some calls for downside protection and additional income.  A good choice is Microsoft (MSFT) with a current dividend yield of 2.77 percent and a beta of only 0.78.  In addition, the Company just beat earnings estimate and year over year earnings.

For the fiscal second quarter ended Dec. 31, revenue rose 14% to $24.52 billion, partly reflecting the release in November of a new Xbox videogame console and a fresh version of Microsoft’s

Surface tablet computer ahead of the holidays.

Overall, net income climbed to $6.56 billion, or 78 cents a share, compared with $6.38 billion, or 76 cents a share, in the year-ago quarter.  Analysts, on average, estimated Microsoft would post earnings of 68 cents a share on revenue of $23.7 billion, according to Thomson Reuters.

The company said its devices and consumer revenue grew 13% to $11.91 billion, while commercial revenue increased 10% to $12.67 billion.

On November 19, 2013 the board of directors at Microsoft had approved a dividend of $0.28 per share. The dividend is payable on March 13, 2014 to shareholders of record on February 20, 2014.

The stock has landed on the “Jefferies Highest Conviction Franchise Picks for Big Upside in 2014.”  Jeffries had this to say about Microsoft in this report, “With the Xbox One poised to be one of the fastest selling gaming consoles ever, the fourth-quarter sales for the company were outstanding. Investors are paid a very solid 3.1% dividend. The Jefferies price target for the software giant is $42.”

Last week, analysts at Deutsche Bank have upgraded their coverage of Microsoft to a Buy rating from a Hold, while raising their price target on the stock to $40 from $32 a share.

Also, Microsoft has an equity summary score of 9.4 out of 10 for a very bullish outlook according to a consensus of analysts.

Investors can look at selling a call option to get some downside protection and additional premium for income.  The basics of a covered call is that an investor can sell one call for every 100 shares of stock owned.

One potential covered call trade is to sell the March or April 2014 38 call option.  Under this scenario, your Microsoft shares will be called away if the stock price is above the strike price of 38 on March 22. So the investor is giving away the stock price upside as long as they are short the call.

However, investors will receive a call premium for each call sold.  This gives the investor downside protection to around the $36 price level.  Investors will also get the $0.28 dividend.  In total, this covered call trade with the cash dividend can potentially create a 5% return over the next 2 months.

Microsoft May be Worth a Look Here

Windows 8 has gotten bad reviews, its mobile push has stalled and it’s facing a murky market for corporate software.  But despite all those headaches, Microsoft Corp.(MSFT) has seen its stock rising.  The software giant’s shares have jumped 14% over the past three months.  The stock has a current dividend yield of 2.82% and is a regular 15% per year dividend increase stock.  The Company will unveil the new X-box next month.  The worst may be behind this software giant.

Microsoft reported Q3 results of $20.489 billion in revenue and EPS of $0.72, compared to consensus of $20.497 billion in revenue and EPS of $0.68.

Microsoft reported March quarter EPS and operating margin ahead of consensus expectations with increased expense controls, while revenue was essentially in line with consensus expectations—with Windows, Microsoft Business Division, and Server & Tools sales falling slightly below estimates and the Online Services and Entertainment & Devices divisions exceeding forecasts. Although the PC market continues to put pressure on Windows and Office revenue and server shipments have been slow, Microsoft effectively managed expenses during the quarter and reported improving growth in OSD and Windows Phone.

Going forward, although PC shipments are expected to remain weak in the June quarter, we expect the combination of more attractive price points, the ramp of new chipsets from Intel, and greater adoption by OEMs of touch screens for ultrabooks and laptops to drive greater adoption of Windows 8 devices in the second half of 2013 and into 2014 than the market appreciates (particularly in the business user segment with the eventual release of Surface Pro 2). Furthermore, we expect the end-of-life of Windows XP in April 2014 to drive growth in the professional PC segment.

Based on these dynamics, we believe that the rate of decline in PC shipments is bottoming, and with continued better-than-expected cost controls, improving OSD and Windows Phone revenue, a new Xbox cycle on the horizon, and solid long-term competitive positioning and near-term product launches in MBD and S&T, we expect Microsoft’s recent outperformance to continue.

Our fiscal 2013 estimates are adjusted to revenue of $78.812 billion and EPS of $2.68 from revenue of $81.514 billion and EPS of $2.78.

We maintain our Outperform rating and our target price of $38. At a 9.7x NTM P/E multiple, Microsoft trades at a 33.8% discount to the S&P 500.

A-Rated Dividend Stocks with 15% or more Earnings Growth Next Year

For investors wanting to have their cake and eat it too, we have some great stocks to consider.  All of these stocks carry the S&P Quality Rating of A, A+ or A-.  Then, they all pay dividends and have a projected EPS growth of 15% or more for next year.  So what you are getting is a fundamentally strong company that pays dividends and produce great earnings for potential price appreciation in the next year.  All of these stocks are up at least 10% year to date easily beating the S&P 500.  Here is the list of high quality stocks with high earnings growth.

Computer Programs and Systems, Inc., (CPSI) a healthcare information technology company, designs, develops, markets, installs, and supports computerized information technology systems to small and midsize hospitals in the United States.  Total revenues for the first quarter ended March 31, 2012, increased 10.2% to $44.5 million, compared with total revenues of $40.4 million for the prior-year quarter. Net income for the quarter ended March 31, 2012, increased 5.1% to $5.6 million, or $0.51 per diluted share, compared with $5.4 million, or $0.49 per diluted share, for the quarter ended March 31, 2011.   CPSI is projected to increase earnings 19.2% next year.  CPSI has a dividend yield of 3.22% which was increased 28% in the past year.  CPSI has no debt and trades with a beta of 0.87.  CPSI has an equity summary score of 7.5 out of 10 for a Bullish outlook.

The Toro Company (TTC) designs, manufactures, and markets professional turf maintenance equipment and services worldwide.  The company reported Q2 earnings of $2.26 per share, versus the Capital IQ consensus of $2.14. Revenues were $691.5 million, versus the analyst estimate of $676.4 million.  For FY12, the company expects EPS of approximately $4.30, in the lower end of its previously announced guidance range of $4.30 – $4.35.  This compares with the analyst estimate of$4.29.  The company also expects revenue growth of 7% – 8% year-over-year.   TTC is projected to increase earnings 15.9% next year.  TTC has a dividend yield of 1.77% which was increased 10% in the past year.   On May 24, 2012 the board of directors at Toro Co approved a 4 for 2 stock split.  New shares will be granted on June 29, 2012 to shareholders of record on June 15, 2012. Beginning on July 2, 2012, the security’s price will reflect the split adjusted price.  TTC has an equity summary score of 8.4 out of 10 for a Bullish outlook.

Technology giant Microsoft (MSFT) just announced a new tablet device to compete in the portable computing market and the future release of Microsoft Phone 8.  MSFT posts $0.60 Q3 EPS versus Capital IQ consensus forecast of $0.58.   MSFT had solid results driven by outperformance in Windows, Server & Tools, and Microsoft Business Division, as PC demand has started to recover, continued adoption of Office 2010, SharePoint, and strong growth in SQL Server.  MSFT revised operating expense guidance downward, now sees $28.3B-$28.7B for FY 12. MSFT is projected to increase earnings 15.2% next year.  MSFT has a dividend yield of 2.61% which was increased 25% in the past year.  MSFT has an equity summary score of 9.0 out of 10 for a VERY Bullish outlook.

Apple’s Future Growth and Dividend Yield

Investors have been suggesting that Apple (AAPL) do something like pay a special dividend with the $98 billion in cash sitting on the balance sheet.  Apple finally moved into action on this topic.  AAPL will pay a dividend of $2.65 per share quarterly, first payable on July 1, for a yield of around 1.8% at current pricing.  Apple also will repurchase up to $10 billion in stock.

We think these actions make sense, given AAPL’s considerable balance of cash and investments of $98 billion as of December 2011.  We note that AAPL plans to use only U.S. cash and investments for these actions, given the adverse tax implications of repatriating foreign earnings.  We think the dividend could attract new investors and investment to AAPL.  AAPL is very close to hitting $600 following the announcement.  While many shareholders agree with this move, some are being alarmist about the maturity of Apple as a stock.  I do not agree with this alarmist theory.

First, Apple has plenty of growth ahead.  It just released the new iPad with recent enhancements and new features.  It has Apple TV in the works for a new platform growth.  Then, you still have the iPod and iTunes that will continue to evolve over time to require upgrades and new service arrangements leading to updated products.  The iPad and iPod will evolve over time like Microsoft Windows did throughout the past two decades with new releases as the software matured.  Apple has a projected EPS growth of 19.5% over the next 3-5 years compared to 7.96% for Microsoft.  AAPL is still a growth stock for the next few
years.

Back in 2005, Microsoft was paying a quarterly dividend of $0.08 for an annual dividend yield just above 1.0%.  Today, MSFT pays an annual dividend of $0.80 with a 2.5% dividend yield.  Over the past 5 years, MSFT has an annual dividend growth rate of 15%.  Apple’s new dividend is starting at 1.8% but I
see it growing over the years similar to MSFT.

Using my stock valuation and dividend model (see chart below), AAPL is projected to be a great long-term dividend stock.  It is projecting that Apple is trading at a 5% discount to a fair value of $630.  The model is projecting that Apple will grow dividends 15% during the next 10 years.  This dividend growth rate is comparable to Microsoft over the past five years.  Using the dividend growth rate, Apple will have a yield on cost of 7.1% in 10 years with a 39% payout ratio.

Click to enlarge

4 Stocks with AAA Ratings

Rating agencies — S&P, Moody’s and Fitch — analyze risk and give debt a “grade” that reflects the borrower’s ability to pay the underlying loans.  The safest bets are stamped AAA.  That’s where U.S. debt has stood for years. Moody’s first assigned the United States a AAA rating in 1917.  The country’s new S&P rating is AA+ — still strong, but not the highest.

There are currently four U.S. companies that have a better credit rating than their own country, according to Standard & Poor’s: Automatic Data Processing, Exxon Mobil, Johnson & Johnson, and Microsoft.

For Exxon, J&J and Microsoft, S&P reaffirmed their AAA ratings recently, saying that “given the global and diverse business lines and significant financial strength” of the companies, “we expect the borrower to continue to fulfill its financial obligations, even in a sovereign default scenario.” S&P said the same of ADP, even though most of its customers are U.S.-based.

Depending on your trust in the rating agencies, the four horsemen (JNJ, ADP, MSFT, & XOM) are financially strong and have the ability to cover their debt.  These four companies are non-financials so the U.S. debt downgrades will not affect their ability to cover debt.

Of course, the real kicker is that these stocks all pay a dividend and frequently raise their dividends each year.  These stocks may be long-term holding to sell calls on each monthly for monthly income while also collecting the dividend.  If they get called away, then pick a new entry point and sell cash-covered puts to buy the stock.  This is the rinse and repeat trading philosophy.

For more on this topic: CNNMoney

 

The Safe Trade for a 15% Yield

As a reader of this blog, you know we focus on generating monthly income from investing.  A favorite and safe way to accomplish this goal is through writing calls on stocks.  Done correctly, you can achieve yirlds in the double digits without the worry of a dividend cut or significant price decline.  When you hear a suggestion to purchase a stock with a 15% yield you automatically go on code alert as there must be something wrong with a stock yielding this much money.  In most cases you are right to be alarmed but today I will show you a safe way to get a 15% yield.

In the current market, Microsoft seems to be a hated stock as it is large and its fast growth days are behind it.  However, you can use a stock like this to your advantage if traded properly.  Microsoft is trading at around 10 times earnings indicating it is relatively cheap at the current price of $27.25.   Microsoft is sitting on about $50 billion in cash equivalents and still has hugh profit margins.  This is a perfect setup for a safe stock to use for covered call trades.

The strategy is to buy 100 shares of Microsoft stock and use a monthly call trade to generate monthly income.  Microsoft pays an annual dividend of $0.64 per share of $0.16 per quarter.  This equals a yield of 2.4% in dividends.  So how do you get from a 2.4% yield to a safe 15% yield?  This is where you add the monthly covered call write.  On average, an at-the-money call will sell for $0.30 for MSFT.  Some months have higher premiums than others and vice versa.  By selling 1 ATM call each month for an average of $30 per month will generate a total of $360 over a one year period.  based on a total cost of $2,725 for 100 shares, the covered call will produce a yield of 13.2%.  By combining the covered call yield (13.2%) with the dividend yield (2.4%) you get an annual yield of 15.6%.

Microsoft stock has support around the $24 level so there is little downsize risk.   The stock has a typical volatility at around 25% or lower.  In the case the stock moves in the money, let it get called away and keep the premium.  If not called away, then continue to sell monthly calls ATM to generate more income.

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