If this month’s earth-shattering vaccine news from Pfizer (NYSE:PFE) has you thinking about buying the stock because it’s destined for monster gains – think again. PFE stock is not a growth play.
It’s a cash-flow vehicle.
But don’t take my word for it. Let the market be your guide. The tribe immediately rejected Pfizer’s bid to run wild after the news hit.
The message was clear. Stick to your lane, little stock. You’re a high dividend-paying, stable security with a history of enriching shareholders through those delicious quarterly checks. Perhaps someday your price chart will evolve into a rip-roaring uptrend, but not today.
By itself, this doesn’t mean PFE is not a great buy. It’s a wonderful candidate for income seekers. But, as I said, if you’ve come in search of rapid price appreciation, I fear you’ll be disappointed.
A Closer Look at PFE Stock
The S&P 500 sports a dividend yield of 1.48% and should be considered our baseline. Companies that offer payouts north of 1.48% are officially interesting as income-generating candidates.
Those that offer less aren’t worth your time. So, how does Pfizer compare to the S&P? It’s nearly three times higher at 4.2%. When you boast a steady income stream of that magnitude, well, you can be forgiven for not leaping higher with every market rally.
Of course, it would be nice if income generators also grew over time. And, to be fair, PFE has had modest growth over the past decade. But in recent years, the lion’s share of the return has come via quarterly dividends.
Now, if you want to juice the return, there are two options available. First, you can amp up the leverage by purchasing shares on margin. Suppose, for instance, instead of committing 100% of the stock cost, you only put up 50% of it. The dividend yield of 4.2% would then double to 8.4%.
In other words, the traditional investor would pay $3,620 for 100 shares of stock to acquire the annual dividend of $1.52. Purchasing shares on margin, by contrast, would only require $1,810 for 100 shares, thus getting access to the yearly payout of $1.52.
Buying on margin, however, is not without its risks. It’s a double-edged sword that can accelerate gains and losses. For example, a 50% loss in PFE stock would create a 100% loss of your capital if you acquired shares with two to one margin.
A second alternative for enhancing yield lies in the options market with covered calls.
Pfizer Stock Options Beckon
Perhaps the most glaring difference between the margin route and using covered calls is leverage. While buying on margin increases risk, selling covered calls decreases it. You’re attempting to enhance your returns by making monthly promises to sell your stock at a particular price rather than buying with borrowed money.
This should appeal more to the conservative, risk-averse investor.
The covered call goes by many names, including a buy-write, covered stock, and covered write. Regardless of your preferred moniker, it’s a strategy that consists of buying 100 shares and selling one call option. You get paid a premium in exchange for obligating yourself to sell shares.
Typically, traders sell one-month, out-of-the-money options. This allows you to profit on the stock before you have to relinquish your shares. Additionally, the shorter time frame translates into a higher rate of time decay and more flexibility in modifying the strike price from month to month.
With PFE at $36.20, you could purchase 100 shares and sell the Dec $38 call for 55 cents. As long as the stock remains below $38, you’ll pick up an extra $55 in income for the next 24 days. And if Pfizer does push above $38, then you’ll have to sell the stock, thereby capturing another $180 of profit ($38 – $36.20, x 100 shares).
Here’s the bottom line. Pfizer is an attractive cash-flow stock, but covered calls can make it even better.
On the date of publication, Tyler Craig did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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