by Travis Johnson, Stock Gumshoe | April 17, 2009 10:25 am
Tom Dyson edits the 12% Letter — a newsletter that, you will probably be unsurprised to hear, aims to recommend investments that provide high income using dividends (and other strategies).
His publisher has been pushing out an ad lately that touts their “dividend capture” strategy, which I don’t have the heart to describe yet again — this is, essentially, a fairly active but conservative strategy of buying stocks and selling short term calls against those stocks, then selling the stocks as soon as the call options expire (or letting the stock get sold in an exercise of those options). This is something we’ve jabbered about here at the Stock Gumshoe any number of times, and while it’s certainly not risk-less it can absolutely be an effective strategy for gradual income accumulation, though it means quite a lot of trading so be careful with your taxes and commission rates. If you want more on this kind of strategy, you can review any of the many articles I’ve written about selling covered calls — the most recent one was about an ad for Advanced Income, another newsletter from the same publisher.
I’m not going to go into detail on the strategy again right now, but I’ll run through an example in a few minutes, once we’ve got one of his stocks to work with …
Dyson also teases us that he’s found America’s #1 Millionaire Maker — and in case those words weren’t strong enough, he adds that “this investment is like no other in America today. You simply put your money in… and never have to worry about again.”
Now, I kind of like Tom Dyson (well, his writing at least — I don’t know him personally) — most of his stuff that I’ve seen is interesting, and he is one of the few newsletter editors who actually had enough confidence and/or humility to ask his own subscribers to go to the Stock Gumshoe Reviews site and review the 12% Letter. That also helped his cause a bit, since the number of reviews has a significant impact on your ranking, (I think it’s more compelling to have a decent average review from 30 people than a great review from one person), so the 12% Letter is now the fourth-ranked income-focused newsletter on the site … negative and positive reviews on this one are actually close to being evenly matched, but scanning them is a good way to learn a bit about what current subscribers might think of the service.
That said, it’s hard to swallow anyone telling us that you can “put your money in… and never have to worry about again” for any investment, especially now, when so many people are truly desperate to shed their stock worries.
So if they’re wiling to go out on a limb like that, we should figure out what the investment is — yes?
Here’s an excerpt from the ad, with a passel o’ clues:
“I call it America’s #1 Millionaire Maker, (you’ll understand why in a minute). Financial columnist George Will says it ‘has created more millionaires… than any other economic entity, anywhere.'”
“This investment has paid quarterly dividends every year since 1976. And get this: The payments you receive have gone up every year since then. In the past three years, payouts have gone up 100%… in the past decade, payouts have increased a whopping 920%!Are you getting our free Daily Update
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“There is probably no better way to compound your wealth in America. In the past 20 years, this simple investment has gone steadily up… returning 1,118%.
“Even during 2008, the worst year in the stock market in a generation, America’s Compounding Machine returned 10% gains to investors… while everything else was collapsing.
“The Washington Post wrote about how this is one of the few investments in the world to go up in 2008. The paper’s January 25th edition said: “In a financial crisis this complicated, it’s nice to know that some simple economic truths endure.”
“Newsweek recognized the opportunity too, and in its January 19th issue called this investment: a ‘star of the recession.'”
A Denver resident named Willis Simms says, ‘it gives very average people an opportunity to accomplish incredible things…'”
OK, so that’s a good lot of clues — which is nice for a Friday, I hate for there to be too much bustle at Gumshoe Headquarters while we await the arrival of a sunny Spring weekend. But I can tell you that this is …
I can actually almost see the golden arches from out of my office window here … if it wasn’t for that damn consulate building blocking the view, so I know the draw that McDonald’s has for Americans (and especially kids) everywhere. And I’ve certainly bought my share of Happy Meals.
And it’s true, McDonald’s has been a “star of the recession,” and it has, despite periods of melancholy (like when that “Super Size Me” movie came out), been a spectacular stock, with a soaring share price (relative to the rest of the market, at least) and a nicely increasing dividend. And it may well be that this is the strongest compounding, dividend growth stock out there right now, and certainly one that has fought off the recession pretty well, and even put the fear of God into Starbucks (though the McCafe, in my limited experience, provides products that are not quite as good as Starbucks, for about the same price).
Actually, you could probably build a pretty decent investment strategy using just these kinds of retail-oriented companies that highbrow folks love to hate, but secretly shop at anyway — McDonald’s and Wal-Mart might be a pretty good start to that list.
But I do want to point out that Dyson’s ad mixes constituencies — the “millionaire maker” stuff is about franchisees — here’s the quote from a George Will column from 2007:
“McDonald’s exemplifies the role of small businesses in Americans’ upward mobility. The company is largely a confederation of small businesses: 85 percent of its U.S. restaurants — average annual sales, $2.2 million — are owned by franchisees. McDonald’s has made more millionaires, and especially black and Hispanic millionaires, than any other economic entity ever, anywhere.”
And the “Willis Simms” quote is actually from a former McDonald’s vice president, Willis Smart, who was quoted in the book Everything I Know About Business I Learned from McDonald’s talking about working for McDonald’s and their franchisees. I don’t know that he ever lived in Denver, though some other folks quoted in the book did.
The recession-resistant stuff is largely about shareholders and sales growth, to be fair (the Washington Post article that he also quotes is here, by the way), but just because it helps almost any ad to throw that word “millionaire” in there somewhere, as we all have sugar plums dancing in our heads, it is perhaps wise to remember that millionaires made from McDonald’s stock will probably be made, if at all, over decades of compounding (and they’d best start with a substantial investment if they want to speed that along).
Now that we have the stock of the day today, our “Millionaire Maker,” what would we do if we wanted to do a “Dividend Capture” using what Dyson calls the “Tier Two Dividend” by selling covered calls? Let’s run through an example:
McDonald’s stock is currently selling for about $55.50, and it has a $2 dividend (annually) for a yield of 3.7%. So you could happily compound that dividend if you like, and hope that the dividend continues to grow (the next ex dividend date will probably be in mid-May sometime).
But for this “dividend capture” strategy, you don’t want to wait for real dividends, you want to generate the income yourself by buying the stock, selling a call, waiting for the call to expire, and then (according to the way he describes it in the ad) then selling the stock on the day after the option expires.
Here’s how it would work for McDonald’s, in one example (I don’t know if this is what Dyson is currently recommending, of course, just an illustration of the strategy):
Buy 100 shares of McDonald’s for $5,550.
Then sell one call option contract against those shares — in this “in and out” strategy you’d want a near month that’s close to the money, so let’s say you sell the May $57.50 call. Currently the bid on that is a dollar, so you pocket $100 for selling that call.
Then you hold on and wait for the expiration date, which is May 16 (last trading day before expiration is Friday, May 15) — exactly four weeks away. Here are the likely scenarios:
1. McDonald’s shares drift around at about this price for four weeks. They don’t get over $57.50 by expiration date, and you sell your shares on Monday, May 18. Let’s say the shares have gone to $56 on that day, so you sell at $56, meaning you made 50 cents a share on the stock plus $1 a share by selling the option for a gain of $1.50 in one month. That’s about 2.7%, which, if you did it over and over every month, would get you a nice annual gain of about 30%.
2. McDonald’s shares soar to $58 or higher before expiration, and the call option you sold is exercised so you have to sell the shares for $57.50 as agreed. That gets you a profit of $3 a share (the $2 move from the $55.50 you paid, plus the $1 you got for selling the option), which is a gain of more like 5.4%, annualizing out to a much better 60% or so if you do it over and over.
3. McDonald’s shares crash for some reason, falling, for example, to $40. You could have put a stop loss into effect, but since you’ve sold an option against your shares you first have to buy back the options (for far less than a dollar, most likely, if the stock was dropping) before you sell the shares. You’ll still lose money, almost as much as all other shareholders — the blow may be cushioned by the $1 you got for selling the option, but if the stock falls fast or far the cushion may not be soft enough to make you happy.
So that’s essentially how it works — and keep in mind that I didn’t include commissions in each of those examples, but they could easily really bite into your returns, especially if you’re just doing the minimum (buying 100 shares and selling one call option). If you have more capital to deploy the costs become a much smaller issue, so if you can buy 1,000 shares and sell ten options you won’t have to worry as much about commissions.
This is something Dyson makes clear in the ad, to be fair — he has three qualifications that people must meet to do this kind of “dividend capture:”
“#1: You need some working capital. If you want to take full advantage of this opportunity, you need some working capital. Remember, you’ll be receiving income from the shares you own, so in order to make the payments worthwhile, you’re going to want to own at least a few hundred shares. To do that, you’ll probably need to be able to dedicate at least $5,000 to $10,000 of investment capital.
“#2: Trading Frequency. The second thing I want you to realize is that to take advantage of the Dividend Capture, you need to be willing to trade out of your positions in roughly 10 to 20 market days.
“#3. The eligibility form you must complete. Believe it or not, most Americans are not eligible to take advantage of the Dividend Capture Strategy, simply because they have not filled out a simple 2-page form with their broker, which establishes your eligibility.”
The only thing I haven’t mentioned is that “eligibility form” — for those of you who don’t currently trade options, that’s just a form that your broker will make you fill out (usually online, though sometimes there is a paper form) before they approve you for options trading. Typically you just have to tell them that you have enough experience, and enough money, to play these somewhat higher risk games, and that you’ve read the CBOE booklet on options trading and understand the risks and obligations. Other than suggesting that you actually read the booklet, I don’t have much to add to that.
So … anything you’d like to add? An opinion about the 12% Letter for the Reviews site? Thoughts about McDonald’s stock, which everyone seems to love these days? Other strategies you like to use for selling covered call options, or stocks that lend themselves to this kind of trading? Let us know with a comment below.
Full disclosure: I don’t own any of the stocks mentioned above, but since I mentioned it in today’s free email update I should note that I do own shares of Google (GOOG) — I won’t trade in any stock mentioned in this article, including GOOG, for at least three days.
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