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Use Market Volitility to Increase Your Income

In this article, I talked about 5 different ways to increase your investment income. Here’s another advanced way: use market volatility to your advantage.

If you look at how the stock market has performed over the last two years, it has gone up and gone down quite a lot, sometimes violently in a single day. At a lower detail level, at individual companies you will find that during each cycle some companies perform better than others, while others may falter at a larger clip.

Market volatility works in your favor because when an income investment falls in price you earn more for the same amount of investment.

Example: Let’s say that an investment is worth $50, and earns $1/year in income. If the investment, due to market volatility goes down to $40 and you buy it at that price, you will still earn $1/year. You just got it for less.

Here’s a simple strategy to take advantage of the situation.

First, Collect Dividends But Do Not Reinvest Them.

Most brokers offer the ability to reinvest dividends/interest income automatically back into the same security when they are received. (Check with your broker – not all securities may be available for this option). However, if you do not automatically reinvest, you will then accumulate money in your account. Hold this money.

Evaluate All Your Positions / Watch List Stocks

OK, since you have a bunch of money (the un-invested dividends/interest plus any new money you have added), seek out the most attractive investments that you already hold or others that you have wanted to buy but perhaps are now becoming attractively valued.

Buy the Most Attractive Investments

Put your money to work in the most attractive investments. By consistently buying the most attractive investments over time, you will increase your income more than if you simply put the reinvestment on autopilot.

A IncomePort Example

In the IncomePort we own some high quality companies. If we want to add to some of our existing positions, we need to evaluate each to determine whether or not it’s attractively priced. I will compare the attractiveness of two of our positions: Realty Income Corporation (O) and Philip Morris (PM).

If you look at the current market downturn for May 2010, it’s easy to see that (PM) has been hit harder than (O). It’s down almost 20% from its 2010 high, while (O) is down only 10% from it’s 2010 high. Here’s a more detailed look.

Realty Income Corporation (O)

  • Trading above it’s 200 day EMA, near its 50 day EMA. Technically the stock is still in ‘bull’ mode.
  • Trades at 17X cash flow, which is expensive relative to piers and historical valuation.
  • Dividend yield, at 5.30%, is below average relative to its history.
  • Recent dividend increases have been weaker than in the recent past, just 4% last year. (still not bad considering the state of the economy).

Philip Morris (PM)

  • Trading below it’s 200 day EMA, below its 50 day EMA. Technically the stock is in ‘bear’ mode.
  • Price to earnings multiple is 12X, while expected 5 year earnings growth rate is 12X. Very attractive valuation for that amount of growth.
  • Very attractive 5.30% dividend yield, that complements the earnings growth.
  • Expect an increase in dividend of 8-10% this year in August, given recent earnings statements and historical company dividend policy.

If I had to chose between these investments, right now Philip Morris (PM) is much more attractive.

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