General Motors (GM) bankruptcy trade

With General Motors expected to file for bankruptcy soon, GM stock price has been in a freefall. In fact shares have hit the lowest levels since 1932, which was the year Dow Jones Industrials Average bottomed amidst the Great Depression. The stock price is also below $1, making shorting the stock almost impossible. Bankruptcy was one of the options for the major US automakers, when I analyzed the sector back in November.
According to this Bloomberg article, once the company files for bankruptcy , the US government would get $30 billion from the US federal government as well as 9.5 billion from the Canadian government. In return the US government would own 60% of the “new” General Motors once it emerges from bankruptcy, while the Canadian government would own 12%. The United Auto Workers health trust fund for retirees will end up owning 17.5 percent of the new company with warrants to purchase an additional 2.5 percent in exchange for forgiving GM the $20 billion it is owed by the Detroit automaker. Bondholders and other creditors would get a 10 percent stake in the new GM, with warrants for an additional 15 percent, in exchange for $27.1 billion unsecured debt according to Bloomberg. If successful, GM will emerge as a leaner company with a smaller work force, fewer plants and a trimmed dealership network.
Shareholders would most likely get wiped out, with their shares being worthless once GM emerges from bankruptcy.
So how can you play the GM bankruptcy and potentially make money in the process? First, If you hold GM stock, I wouldn’t hope for the company rising to $10 anytime soon, so I would consider selling. Otherwise the answer is pretty simple: play it with options.
If you buy puts on GM, and the stock does become worthless you would end up making a nice gain in the process. Options are contracts which give the right but not the obligation to buy ( call) or sell (puts) a security on a given date ( expiration date) at a given price (strike price). In GM’s scenario, a bearish investor would consider purchasing puts on the stock.
I would consider GM puts with a strike price of $1 for this trade. The June 2009 $1 puts closed at $0.60;July 2009 $1 puts closed at 0.67 , while September and December $1 puts closed at $.71 and $.75 respectively.
The far out puts such as the September and December 2009 ones are much more likely to yield any significant profits, since this leaves investors ample time for the company to go bankrupt.
This is a highly speculative trade that shouldn’t be entered with more than 0.5% of your total portfolio.

Full Disclosure: None ( But I am looking to open a position in Sep or Dec 2009 $1 puts).

Relevant Articles:

- The future for US Auto Stocks
- GM Bankruptcy Filing Will Bring Taxpayer Ownership, Less Debt
- General Motors (GM) bankruptcy trade

Dividend Investors Running With the bulls

The stock market index S&P 500 has risen by 37.8% from its lows in early march. The S&P 500 is also almost 1.80% higher since the beginning of 2009. Investors are now being bombarded with conflicting advice from both from the bullish and the bearish camp. The bears claim that the rally overextended and due for a sharp correction once S&P 500 falls below 878. The bulls believe that bears are in for a surprise once S&P 500 breaks out through the resistance above 930 and the next leg of the new bull market begins.

Dividend Investors on the other hand represent a camp of their own. They keep receiving their dividend checks, holding on to the dividend growers and disposing of their dividend cutters and eliminators. Dividend Investors are quietly re-investing their distributions into more shares and are watching their income grow in the process. It doesn’t matter to them if the S&P 500 is at 1500 or at 700 as long as the dividends are being paid, and most importantly dividends are not being cut, which shouldn’t be a problem for most diversified dividend growth portfolios.

Several companies rewarded their patient investors with dividend raises.

SUPERVALU INC. (SVU), which operates combination stores, food stores, and limited assortment food stores, increased its quarterly dividend by 1.45% to 17.5 cents per share. In addition to that the company announced a program authorizing it to purchase up to $70 million of the company's common stock. SUPERVALU INC. is a dividend aristocrat, which has increased its quarterly dividend in each of the past thirty-six years. The stock currently yields 4.30%.

Lowe's Companies, Inc. (LOW), which operates as a home improvement retailer in the United States and Canada, approved a 5.9% boost in its quarterly dividends to 9 cents/share. Lowe's Companies, Inc. is a dividend aristocrat, which has increased its quarterly dividend in each of the past forty-seven years. The stock currently yields 1.80%.

The H. J. Heinz Company (HNZ), which engages in the manufacture and marketing of food products for consumers, and foodservice and institutional customers, raised its quarterly dividend from 41.5 to 42 cents per share. The H. J. Heinz Company had been a member of the S&P dividend aristocrats index between 1990 and 2002, before it cut its distributions in 2003. The company has resumed increasing its dividends to shareholders since 2004.
The stock currently yields 4.60%.

PPD, Inc. (PPDI), a contract research organization, that provides drug discovery and development services, post-approval expertise, and compound partnering programs, increased its annual dividend payments by 20% to 60 cents per share. PPD, Inc. has consistently increased its quarterly dividends since 2006. The stock currently yields 3.00%.

Monro Muffler Brake, Inc. (MNRO), which provides automotive undercar repair and tire services, increased its quarterly dividend by 16.70% to 7 cents per share. Monro Muffler Brake, Inc. started raising dividends regularly since it initiated its dividend policy in 2005. The stock currently yields 0.90%.

Fred's, Inc. (FRED), which sells general merchandise through retail discount stores and pharmacies, increased its quarterly dividend by 50% to 3 cents per share. Fred's, Inc. doesn’t have a history of regular dividend increases. The stock currently yields 0.90%.

Flowers Foods' (FLO), which engages in the production and marketing of bakery products in the United States, raised its quarterly dividend by 17% to 17.50 cents per share. Flowers Foods has increased its quarterly dividend in each of the past 7 years. The stock currently yields 2.90%.

Full Disclosure: None

Related Articles:

- When to sell my dividend stocks?

- Should you re-invest your dividends?

- Dividend Investing vs Trading

- MLPs for tax-deferred accounts

MLPs for tax-deferred accounts

Master Limited Partnerships are very good investment vehicles for individuals looking for high current dividend income. There are some tax issues with reporting MLP income in a taxable account, which led me to explore investing in MLPs through an IRA or ROTH IRA account.
In a taxable account, most of the distributions are considered a return of capital, and thus you do not pay taxes on that portion. This tax deferral does decrease your cost basis however, which could mean higher capital gains or ordinary income taxes if you sell. Because of the supposedly complicated tax returns from MLPs, some investors are shunning MLPs as a class althogether. Others are considering simply purchasing those MLPs in a tax advantaged account, and forget about them.

For non-taxable accounts however, there is a gray area from a tax perspective whether or not one could hold MLPs there. The distributions that an individual that holds a master limited partnership in an individual retirement account receives could be considered unrelated business taxable income subject to taxation. As long as the UBTI from all MLPs in an IRA does not exceed $1000 in a given year, your partnership distributions won’t be taxed.

If the UBTI does exceed $1000 however, the custodian that holds your IRA would have to file a form 990T to the IRS. The tax is paid out of the IRA on the net income from your MLP distributions, which are taxed at the corporate rate.

The UBTI has generally been a non-issue for most MLPs over the past few years, but this isn’t guaranteed. Some like Kinder Morgan (KMP) have even had a negative UBTI in some years, which could be offset against any positive UBTI amounts from other MLPs. Kinder Morgan is one of my Best High Yielding Stocks for 2009.

I do believe however that paying a small tax out of your MLP distributions in an IRA shouldn’t be a big hassle, since distributions are rich and taxed at the corporate rate. One should check with their IRA custodian however in order to asses the amount of fees that the IRA has to pay if the UBTI threshold is exceeded.

If you do not feel comfortable putting ordinary master limited partnerships in a tax-deferred account but feel that you might be missing out, there are still workarounds for this situation. There is an easy way to invest in two MLPs without worrying about taxes too much – Kinder Morgan (KMP) and Enbridge Energy Partners (EEP). They pay their distributions directly as additional shares, which is similar to automatic dividend reinvestment. If you choose to invest in KMP or EEP in an IRA, consider investing in KMR and EEQ.

KMR and EEQ are great vehicles for taxable accounts as well since their distributions are not taxable when received, and thus shareholders are not issued an annual 1099 tax form. You would pay taxes only when you sell your units.

The taxation characteristics of your investments are just one part of the investment puzzle. Always make sure to investigate the company’s fundamentals and do your homework before investing in stocks.

Several publicly traded closed end funds such as Tortoise Energy Infrastructure Corporation (TYG), Tortoise Energy Capital (TYY), Tortoise North American Energy Corp. (TYN), and Kayne Anderson MLP Investment Company (KYN) provide a proper diversification within the MLP sector. They are suitable for IRAs since they send out Form 1099-DIV instead of K-1, which also makes it easier for investors with taxable accounts to file their annual tax returns. In most cases the dividends received are treated as a return of capital, which reduces your cost basis. In such cases the distributions are not treated as taxable income. Investors would only have a tax liability when they sell their closed end fund.

These closed end funds also do not generate any unrelated business taxable income (UBTI). The main disadvantage of these closed end funds are their steep annual management fees.

Tortoise Energy Infrastructure Corporation (TYG) has an annual management fee of 0.95% plus a 0.19% charge for other expenses for a total annual expense ratio of 1.14%.Tortoise Energy Capital (TYY) has an annual management fee of 0.95% plus a 0.25% charge for other expenses for a total annual expense ratio of 1.20%.Tortoise North American Energy Corp. (TYN) has an annual management fee of 1.00% plus a 0.71% charge for other expenses for a total annual expense ratio of 1.71%.

Kayne Anderson MLP Investment company (KYN) spots an annual management fee of 2.50% in addition to other fees of 3.40% for a total expense of 5.90%.

Because of high expense ratios, I would think twice before investing in those closed end funds. One thing that is certain in the investment world is that higher fees are not necessarily indicative of superior investment performance. If you cut your costs to the bone, you are much more likely to at least track your index benchmark.

Full Disclosure: Long KMR

Get an updated Trend analysis for KMP and EEP.

Relevant Articles:

- Master Limited Partnerships (MLPs) – an island of stabiliity for dividend investors
- Kinder Morgan Energy Partners (KMP) Dividend Analysis
- Best High Yield Dividend Stocks for 2009
- General vs Limited Partners in MLP's

Diversifying into small and mid cap dividend stocks

As a dividend growth investor, my goal is to generate a rising stream of dividend income. Thus I would have to be selective not only about picking individual stocks, but also about selecting companies from a variety of industries, countries and size, in order to avoid a widespread implosion in overall dividend income.

An investor who diversified their holdings across several sectors, shouldn’t have gotten as many dividend cuts in 2008 and 2009, in comparison to an investor whose portfolio was concentrated in certain high-yielding sectors such as financials, Canadian income trusts or business development corporations. In that case diversification mattered.
One troubling fact however is that most of the successful dividend growth stocks that I tend to focus on such as Coca Cola (KO), Johnson & Johnson (JNJ) and Abbott Labs (ABT) are large cap stocks. This could be both good and bad for my portfolio. Most dividend growth stocks have solid competitive advantages as well as large economies of scale, against which few competitors could compete. In addition to that the entry in those markets might be too costly for a smaller producer to challenge the “big guys”. However if I added small or mid cap stocks to my portfolio, my dividend income could be diversified even further.

According to Investopedia, Large Cap stocks are those whose market capitalization is above $10 billions dollars; Mid Cap stocks are those whose market capitalization is between $2 billion and $10 billion dollars while companies whose market capitalization is between $200 million and $2 billion typically represent Small Cap Stocks.
Most large cap companies are the ones, which are mature and stable cash flow generators, which throw off enough cash to expand, reward shareholders and maintain liquidity. It would be difficult for a company with $100 billion in sales to expand at the rate that a company with $1 billion in sales could. Because of this fact stable dividend growth stocks tend to enjoy a lower price earnings multiple. In comparison, most small and mid cap stocks could spend most of their earnings to reinvest back into the business, thus paying little or no dividends to shareholders in the process.
A potential negative for holding the large cap market leader in any industry however is that if the activity in the whole sector declines significantly, chances are that the leader would feel the pinch as well. Despite the fact that the market leader could likely gain market share if competitors go bankrupt or by acquiring weaker rivals, a broad slowdown could hurt it badly.

At the same time a smaller competitor could be flexible enough to gain market share by utilizing some sort of a competitive advantage and actually achieve superior earnings growth and reward dividend investors with higher distributions as its sales skyrocket. Smaller dividend growth companies could have a higher price earnings multiple as the market prices in solid future growth. On the other hand, if earnings growth slows down, the price earnings multiple could shrink, leaving investors with large unrealized losses.
Even if you pick a promising small or mid cap dividend growth stock, chances are it could get acquired by one of the leaders in the industry. Thus, investors won’t be able to fully realize the full growth potential of the small dividend stock. Although shareholders could generate a large capital gain in the process, they would have to find a new promising candidate for their money instead of patiently reinvesting their dividends.

According to Mergent’s, 80% of the constituents of the Broad US Dividend Achievers index are large cap companies, while 14.10% and 5.90% are mid cap and small cap stocks respectively. The Dividend Achievers are corporations, which have increased annual dividends for at least the past 10 consecutive years.
The Dividend Aristocrats, which are S&P 500 constituent stocks with history of increased dividends of more than 25 consecutive years, must have a minimum capitalization of $3 billion dollars before they are eligible to join the elite dividend index. Of the 43 companies presently in the index (after omitting the dividend cutters year-to-date and Rohm & Haas, acquired by Dow Chemical), 21 or almost half have market capitalizations of less than $10 billion dollars.
You could find a list of mid cap Dividend Aristocrats below:

Link to the tableJust remember that not all of the stocks presented below are investment recommendations. At this moment only Stanley works (SWK),Cincinnati Financial (CINF), Dover (DOV), VF Corp(VFC), Sherwin Williams (SHW), Clorox (CLX), Consolidated Edison (ED) and McGraw Hill (MHP) fit my entry criteria to initiate positions or re-invest dividends.

For a full list of the current dividend aristocrats ranked by market capitalization (minus any acquired companies and minus any dividend cutters in 2009), check the chart below:
Link to the table

Full Disclosure: Long CINF, FDO, MTB, GWW, SHW, CLX, ED, MHP, APD, AFL, ADM, ADP, KMB, EMR, MMM, MCD, PEP, KO, JNJ, PG, WMT

Relevant Articles:

- My Dividend Growth Plan - Diversification
- Why do I like Dividend Achievers
- Why do I like Dividend Aristocrats?
- My Dividend Growth Plan - Stock Selection

The Sweet Spot of Dividend Investing

The following is a guest post from Dave Van Knapp, the author of The Top 40 Dividend Stocks for 2009. Make sure to check his site from this link.

In long-term dividend investing, one needs to control risk in many areas. Risk comes in many forms: selecting unsound companies; purchasing companies whose dividends are in peril; creating a portfolio that is insufficiently diversified; and so on.

Two important areas of risk to a long-term dividend strategy are the initial yield and expected growth rate of the dividend itself.
If you start out with too low a yield, it will take many years for the dividend to grow to where it provides a worthwhile return on your original investment. On the other hand, if you start out with too high a yield, it may well be that the dividend is unsustainable and in peril.
If the company typically increases its dividend at too slow a rate, again the dividend will take too long to grow into a desirable return. On the other hand, if you anticipate too fast a growth rate, the company may not achieve it.Plotting these two characteristics against each other--initial yield and anticipated dividend growth rate--gives us a diagram of the "sweet spot" in dividend investing.

On this diagram, the left (vertical) axis represents the dividend’s likely growth rate. It ranges from very slow (say less than 3 percent per year) to very high (say 20 percent per year or more). The bottom (horizontal axis) represents the initial dividend yield, from very low (less than one percent) to very high (greater than 10 percent).

The red area represents four places you don’t normally want to be. Here’s why:

The left edge of the chart is where the stock’s yield is simply too low to be attractive. I seek initial yields of 3 percent or more. Fortunately, because of the long bear market, a lot of quality stocks that formerly would not have cleared this hurdle now offer yields over 3%.
The lower edge is where dividend growth is too slow. Generally seek a growth rate of at least 4 to 5 percent per year. Even in this slow economy, many quality dividend companies have increased their dividends in 2009 by attractive amounts. Examples would be Abbott Labs (ABT, 11%); Coca-Cola (KO, 8%); Chubb (CB, 6%), Procter & Gamble (PG, 10%), Colgate-Palmolive (CL, 10%), and PepsiCo (PEP, 6%).
The top edge is labeled “Growth Traps.” This is where the dividend’s growth rate is probably unsustainable because it is too high. It’s a “trap,” because a high dividend growth rate is usually an attractive quality in a dividend stock. But when the growth rate is too fast, it usually cannot be continued. The very high growth rate may be a red flag that the company is over-extended in its dividend policy and will need to pull back. The risk in stocks with a high dividend growth history is that continuation of a very high rate of dividend growth is unlikely. Many value investors (including Warren Buffett) consider annual earnings growth of 15 percent to be about the maximum sustainable for long time periods.
The right edge is labeled “Yield Traps.” Again, a high yield is a good thing, up to a point. But extremely high yields often point to a problem. The reason the yield is very high is probably because the stock’s price cratered. While that could simply be the byproduct of the bear market of 2007-2009, it could also be a reflection that the company is in serious difficulty and will need to cut its dividend soon. In 2008 and early 2009, we have seen this time and again, especially among financial firms. It should go without saying that the very finest dividend stocks suitable for a long-term dividend strategy are not in danger of cutting their dividends.

The green area in the middle is the sweet spot: Initial dividend yields of between about 3% and 9%, combined with dividend growth rates of about 4% to 17%. Those are generally sustainable numbers, and it is where we will find most of the best dividend stocks for long-term investing.

Relevant Articles:

- 10 by 10: A New Way to Look at Yield and Dividend Growth
- Yield on Cost Matters
- The Dividend Edge
- My Dividend Growth Plan - Strategy