The two most prominent ways of generating cash flow from the stock market in our opinion is through the collection of dividend payments as well as the writing of covered calls. When the respective investor is utilizing either one (or both) of these strategies, she is literally forcing her portfolio to generate income on a consistent basis.
Most investors invest for capital gain which is to literally buy low and sell high. Warren Buffett though likes to think of his investments from a cash-flow perspective. What this essentially means is that he is willing to invest cash now in order to earn more cash later (from the same investment).
The problem with long-term investing especially nowadays is that we have super liquid markets (especially in the US), which means unrealized gains on an investment can be basically realized for pennies on the dollar at any moment. Many times, though, this maybe the wrong decision.
The reason being is that the investment (even with strong unrealized gains) could be yielding more at the time of sale than when originally taken out. This is why the true cash-flow investor is concerned with the cash flow being spun off by the portfolio every month/quarter. The actual dollar amount of the portfolio comes in a distant second.
For investors with not a lot of capital, the covered call strategy is an excellent strategy to start generating some cash flow. This strategy basically involves owning at least 100 shares of stock and then selling call options against this position. It is an alternative form of renting out your shares, but the stock may also be “called away” if the share price finishes above the strike price at expiration.
One such stock which may suit this strategy at present is Hewlett Packard Enterprise (HPE). The share price is low ($15.64), shares are liquid, and there are plenty of strike options to choose from. Furthermore, the company pays out a dividend yield of 3.04%. To see how suitable HPE is for cash-flow investment purposes, researching the dividend is vital. Why? Because, when using a stock for covered call purposes, there inevitably will be times when calls cannot be sold against the long stock position. In these times, it is vital that the dividend remains strong and preferably grows also. So, from this standpoint, let’s see how sustainable HPE’s dividend is at this present moment in time.
Hewlett Packard Enterprise’s dividend yield comes in at just over 3% at present as mentioned. The company’s forward earnings multiple of 8.5 is well below the average P/E ratio of 22.6 in the S&P 500, so we are off to a good start here.
In terms of dividend growth, HPE has grown its payout by over 38% on average over the past three years. Over the past 12 months, the growth rate has slowed to around 11%. In saying this, operating income over the past while has really increased significantly due to a robust increase in margins across the board. Suffice it to say, we do not see an issue with affordability here at present. Earnings projections continue to increase for 2020 as well, as 2021 which should only help the dividend in the long run.
With respect to how HPE’s financials stack up at present, we look at recent trends in both the firm’s debt-to-equity ratio as well as the interest coverage ratio. HPE’s debt-to-equity ratio in its recent quarter came in at 0.55, which means we have a slightly rising trend here. The firm’s interest coverage ratio at the end of 2019 came in at 9.36, which means this key metric has remained pretty steady since 2016.
Again there is nothing of note here which would make us cautious concerning the company’s financials. Although book value has been getting smaller in HPE, so has its debt. In our potential value plays for example, we invariably look for a debt-to-equity ratio under 1, which HPE has at present. Moreover, as operating profits grow, the interest coverage ratio should also climb which should enable significant dividend growth rates to continue.
To sum up, HPE definitely shapes up as a strong candidate for cash-flow investing purposes. As mentioned above, it is liquid (so covered calls could be used aggressively) as well as being a low-priced stock. Furthermore, increasing margins should ensure that the dividend continues to grow handsomely.
Elevation Code’s blueprint is simple. To relentlessly be on the hunt for attractive setups through value plays, swing plays or volatility plays. Trading a wide range of strategies gives us massive diversification, which is key. We started with $100k. The portfolio will not stop until it reaches $1 million.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.