The Safest Time to Own an 'Income' Stock

Shares of utility companies are generally owned by investors who focus on cash distributions. They typically serve as bond substitutes with the idea that these stocks will outperform fixed income over time due to rising dividend rates. 'Income investors' don't care much about trading. They are content to hold for long periods while collecting yields that pay for living expenses. What happens, though, when shares owned strictly for yield stop making cash payments? Predictably the stocks tank badly. People who bought for yield tend to dump their holdings and move on. New, value-oriented, long-term thinkers swoop in to buy the stock at beaten down prices. Good companies still have earnings power and value beyond just current dividends. PG&E Corp. will almost certainly resume paying cash to shareholders once the legal problems get sorted out. PCG has fallen from over $71 to near $42. That's an almost $15 billion reduction in market cap. Morningstar research estimates PCG's legal settlements will run $5 billion or so, but that amount is far from certain. When the dust settles, it could be higher, or lower. The company has about $800 million of liability insurance coverage available. Suspension of the dividend will save over $1.09 billion annually versus the old $0.53 quarterly payout. The California Public Utility Commission (CPUC) is likely to allow at least some portion of any settlement amount to be recouped through rate increases. Taking all the preceding information into consideration, Morningstar thinks PCG is worth about $52 per share right now. That puts PCG into clearly undervalued territory. The shares now trade for one of their lowest P/Es ever. Even a partial rebound could send the stock back to $53 - $54 strictly based on future prospects for recovery. Value Line assumes that PCG will resume cash dividends before too long. It projects an annual rate of $2.20 per share will be in effect not later than 2020. Reverse engineering a 3.82% yield on that $2.20 amount translates into a $57.59 price target over time. Unless legal settlements run much higher than expected there is real value now in the beaten up shares of PCG. Worst-case, doom and gloom scenarios rarely play out. BP (BP) is still alive and kicking after its oil spill disaster. Ditto that for Volkswagen (VLKAY) after its very serious diesel emissions cheating scandal. Ironically, the safest time to buy stocks like these is after severe bad news accompanied by major share price declines. PCG offers investors two-year options as a way to play a rebound while locking in an extra margin of safety. On Jan. 31, 2018, I was able to snag premiums of $4.60 for the Jan. 17, 2020 expiration date $40 puts and $7.20 for the $45 strikes. Break-evens on those option sales dropped to just $35.40 and $37.80, respectively. Using the deeper-in-the-money Jan. 17, 2019, $50 put @ $10.60 would have provided greater upside while still offering a worst-case, if exercised, price below $40. Future stock market action can never be guaranteed. It is comforting to know, though, that holding PCG at any of the three if put levels shown would have been a winning position 100% of the time dating back to the very dark market days of 2011, when PCG bottomed briefly at $36.80. Fear of the unknown keeps people on the sidelines, making for good deals for traders willing to bet things won't go incredibly badly. Speculative investors could do well buying shares in PCG, shorting its LEAP puts or doing some combination of the two ideas.

The Safest Time to Own an 'Income' Stock

Fear of the unknown keeps people on the sidelines, making for good deals for traders.

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