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This Value Stock Could Yield 20% A Year Without Dividends

 January 16, 2013 11:02 AM

Although it doesn't make for a very interesting story, providing replacement parts for consumers can be just as profitable as unlocking the creative innovation that launches a new industry. Case in point: Cooper Tire & Rubber (NYSE: CTB).

This company makes replacement tires for cars and trucks. It is the ninth-largest tire maker in the world and markets directly to consumers rather than supplying the parts needed for new cars where profit margins can be smaller.

Tariff protection for tires was dropped in 2011, and Cooper fell sharply when traders became concerned that cheap imports from China could hurt the company's business. Those fears proved to be misplaced and Cooper saw sales and earnings rise as the stock price recovered.

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Despite strong financial performance, Cooper is trading with a price-to-earnings (P/E) ratio of about 5, less than half the industry average and well below the market average of about 14. Earnings per share (EPS) are expected to be $3.09 this year, growing to $3.14 next year, and averaging growth of 6.5% a year for the next five years.

Cooper pays a dividend of 42 cents a share, an amount that is well-covered by earnings, for a current yield of 1.6%. The company has paid a dividend for 25 consecutive years but hasn't raised the payout since 1998. Based on the price-to-earnings (P/E) ratio, Cooper is a value stock, but the low dividend payout might not make this the best pick for income investors. Covered calls can be used to increase the income and allow income investors to enjoy a high yield on this low P/E stock.

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With covered call writing, you buy the stock and sell a call option against the shares you own. If the stock goes up and is above the option exercise price at expiration, you will book a short-term profit. If the stock is below the exercise price when the call expires, you will still own the stock and have the chance to write another income-producing call option.

Cooper is trading at $25.83. February $25 call options are trading at $1.35. Buying 100 shares of the stock will cost $2,583 and selling the call will result in immediate income of $135. That reduces the cost basis of the stock to $24.48. If the shares are trading above $25 when the option expires, call sellers will have to sell the stock at $25 and accept a profit of 52 cents per share (2% in five weeks).

I would be happy to earn 2% on Cooper in the next five weeks because gains like that represent an annualized return of more than 20% a year. If Cooper is below $25 in five weeks, we would continue to own the stock and can sell another option. I would be equally happy owning Cooper for the long term.

This is a short-term income trade that could evolve into a long-term income trade. The market will decide when it is time to sell Cooper, but in the meantime, this stock can be used to generate income with a covered call writing strategy.

Action to Take --> Buy Cooper at the market price and sell one Cooper Feb 25 Call at the market price for each 100 shares purchased. Set stop-loss on Cooper at $20. If that price is reached, the call will be worthless and the premium received for the option will be a profit that offsets the loss. Do not set a profit target on the stock. If it is above $25 at expiation, you will make 2% in five weeks. If not, you will be able to sell another call option.

This article originally appeared on ProfitableTrading.com:

This Value Stock Could Yield 20% a Year Without Dividends

-- Amber Hestla-Barnhart

Amber Hestla-Barnhart does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.


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