Updated: Dec 26, 2019
Analyst recommendations are hopeful heading into the new year, but what if we get a rangebound market or modest returns? Isn't there a way we can deploy our capital much more efficiently? Of course! That's why the Dutchmen invented options...
The simplest form of option selling is covered call writing which encompasses two actions: buying stock (in 100 increments) and selling a call against that. You are then obligated to sell your stock at the strike price (the price you're willing to sell your shares for). So, you determine what kind of stocks you want to potentially get rid of and how much upside potential there's left. Collecting option premium while you're waiting is a gift from the gods whereby you accumulate a constant amount of time decay year in year out. Given the eighth world wonder of compound interest, that leads to an incredible amount of additional cash on top of your dividends and unrealized gains.
Here you have my top three covered call stocks which I believe are poised for strong performance in 2020 and all three will provide you with fat and nicely growing dividends. But what if their share price flatlines next year or goes up by less than 10%? By adding the option premia to the equation, you have a very good chance of beating the market next year in case of a rangebound market/moderate returns.
1) Broadcom: Great Dividend Growth, Great Management Team, Great Prospects!
Broadcom should be at the top of your Christmas Eve's wishlist. This dividend star is a designer, developer, manufacturer and global supplier of a broad range of semiconductor and infrastructure software products, Broadcom's product portfolio serves the data center, networking, software, broadband, wireless, and storage and industrial markets. While weaker demand in the semiconductor industry has weighed on several tech companies over the past year and a half, growth is picking up again and Broadcom's last fiscal year has been anything but fantastic. Citing Broadcom's CFO:
We achieved record profitability in fiscal 2019, including free cash flow of over $9 billion, despite a challenging market backdrop for our semiconductor solutions segment. As a result, we are raising our target dividend by 23 percent to $3.25 per share per quarter for fiscal year 2020... Looking ahead to next year, we expect our adjusted EBITDA to expand by more than $1 billion, while we focus our capital returns on cash dividends, with excess cash going towards debt pay down...We remain committed to returning approximately 50% of our prior year free cash flow to stockholders in the form of cash dividends...In addition, we plan to pay down approximately $4 billion in debt in fiscal '20 as part of our commitment to maintain our investment-grade credit rating. " -CFO Tom Krause
While it's dividend growth in excess of 50% isn't going to be sustainable in the foreseeable future, I expect the company to grow its dividend by roughly 12%-15% going forward. It really highlights the merits of investing in a truly undervalued company and letting dividends accumulate over time resulting in a double-digit yield on cost.
But you might say: I want to make even more money if the stock doesn't go up by more than 20% next year. Well, selling the September $370 covered call allows you to not only pocket the dividend of $6.50, but also collect a premium sporting an annualized 5% and 17% upside potential. Reducing your cost basis automatically results in a higher Probability Of Profit and by selling a covered call, you take down your long equity exposure.
To put some context around that, the following screenshots are provided below.
2) AbbVie: Allergan Acquisition Will Create Tremendous Shareholder Value
AbbVie made significant progress in diversifying away from Humira after a turbulent 2019 which saw its share price plunge by more than 40% at some point. By acquiring Allergan, AbbVie's management team decided to highly leverage the balance sheet. However, AbbVie is getting $30 billion in annual non-Humira revenue it expects to grow about 8.5% annually through 2023, nearly three times the industry growth rate. It must also execute on its drug pipeline, which fortunately for it, is the 2nd best in the industry according to EvaluatePharma. RINVOQ and Skyrizi have the potential to become blockbusters with peak sales of 6.5 billion and 5 billion dollars respectively.
By 2021, based on my own estimations, AbbVie's free cash flows will top the 13.5 billion dollars barrier compared to 9.5 billion dollars this year. After substracting the dividend payments of roughly 6 billion dollars for 2021, there's still 7 to 8 billion dollars left to pay down the debt burden.
Based on management projections, post-dividend retained free cash flow will be $10 billion to $10.5 billion per year, and possibly as much as $12.5 billion by 2022. This is why Moody's calls AbbVie's deleveraging plan "credible", specifically the $7.5 to $9 billion per year in debt repayments that are designed to lower net debt/EBITDA from 4.4 to 3.0 by the end of 2021 and then lower still through 2023.
So, you get a more diversified pharmaceutical company, temporarily higher debt profile but a FCF yield in excess of 10% growing at 7%-8% per year not to mention additional buybacks.
By selling the 100 call expiring on September 18th, you'll have an opportunity to make 24.6% on an annualized basis including dividends. A great potential return while the dividends and option premium reduce your cost basis.
3) American Tower: This Rock-Solid REIT Will Make You Very Rich
American Tower Corporation operates telecommunications infrastructure real estate, providing cell towers to mobile carriers, with a portfolio of over 170,000 communications sites - 41,000 properties in the U.S. and 130,000 properties internationally. AMT generates the majority (98%) of its revenues from property operations by leasing of space on communications sites to wireless service providers and other tenants from various industries while services operations (~2% of revenues) offer tower-related services (site acquisition, zoning and permitting and structural analysis) in the U.S. AMT’s solid business model generates 98% of its revenues from long-term leasing contracts to mobile carriers.
The business model encompasses leasing out space to mobile carriers to install and manage their equipment under long-term (10-years) and non-cancellable (resulting in low churn rate) contracts with rent escalations based on fixed percentage (averaging ~3% in the U.S.). AMT anticipates generating about $35 billion (5x of 2018 property revenues) of non-cancellable tenant lease revenues (includes Asia, EMEA and Latin America) over future periods, based upon FX rates and the tenant leases in place as of Dec. 31, 2018. Since 2012, AMT's dividend has grown by a CAGR of 20% which is expected to continue through - at least - 2021.
AMT shares tend to underperform the market during periods of excessive rallies/optimism when there's a shift from high-quality, lower-risk REITs to value/high-beta stocks. When investors are doubtful about the economic outlook, AMT shares are expected to outperform the broader market.
If you feel there's way more to come, just sell the 260 calls expiring on July 17, 2020, collect the dividend and enjoy a maximum annualized return of 29.9%.
Have a great Christmas & Happy New Year! See you in 2020!