Since October I have been urging yield-oriented investors to combine the selection of good dividend stocks with covered calls. This system has been working very well, and readers have asked for more information about how to make these trades.
At the risk of giving away some information about our specific methods, I have decided to go into more detail. I hope that readers find it helpful in meeting their risk/reward objectives.
The combination of dividends and call premium will yield 10% returns +/- whatever happens to the stock. If your time frame is a few years, and your stock picks are reasonable, you need only break even on the stocks to get a return that will solidly beat bonds and inflation. On a total return basis you can aim to double your portfolio in eight years or so, without getting unduly aggressive.
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This is a sweet spot for many investors. You can do it, but it will take a little work. I have already covered several key topics in prior articles in this series. You will do best if you check out the past articles as well as this one. If you want this to work, don't cut corners!
Picking Dividend Stocks
A great dividend stock must first be a great stock!
Too many investors just screen for high yield. Many of these stocks trade as a function of the yield. It is like buying a 100-year bond. If you think that bond yields are going higher, these stock prices will go lower. Here is the chart I ran in my original dividend article:
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If the only idea you got from this article (November, 2010) was buying Caterpillar (CAT), you were in at 80.
Other stocks at the top of a pure yield screen might include companies about to cut the dividend since their payout ratio cannot be sustained by the earnings.