Phillips 66 (PSX) stock still looks undervalued to value buyers with its 4.33% dividend yield and 8x forward P/E multiple. Moreover, covered call and short put investors have attractive income plays.
We discussed the company's earnings and valuation in our last article on May 5, “Phillips 66 Impresses Investors With Its 4.5% Dividend Yield And 10% Total Yield.” At the time PSX stock was at $92.98, and as of today, June 6, it is up slightly to $96.60.
High Total Yield and Low Valuation
We argued that its high 4.5% dividend yield, along with its buybacks, which are about $2.5 billion annually or about 5.6% of its $44.5 billion market cap, give the stock a 10% total yield to investors. That is still roughly the case, although the dividend yield is down slightly to 4.33%.
Moreover, the stock's earnings multiple is still well below its historical average, implying an upside in the price. For example, Morningstar reports that PSX stock has had an average 5-year price-to-earnings (P/E) multiple using forward earnings of 15.78x.
But analysts covered by Seeking Alpha estimate that earnings this year will be $13.94 per share, putting PSX stock on a 2023 forward multiple of less than 7x. Moreover, even though earnings forecasts for 2024 are lower at $11.90 per share, this still leaves it on a forward 2024-year multiple of 8.1x.
That is almost half the stock's historical average multiple. If you believe that stocks will tend to revert to the mean, it implies there is a good upside in PSX stock.
Shorting OTM Covered Calls and Cash-Secured Puts for Income
In my last article, I suggested that shorting out-of-the-money (OTM) calls and cash-secured puts was a good way to make extra income in PSX stock. You can do this while taking a long position in the stock and therefore collect income while you wait for the stock to move to its target valuation.
For example, we reported that the $100 calls expiring on June 2, which were due in 28 days, were attractive at 95 cents per call. That gave investors a covered call yield of 1.0% with less than one month before expiration (i.e., $0.95/$92.31). Since those calls expired worthless, the investor kept both the unrealized capital gain as well as the income. Moreover, at the time the strike price was 8.33% above the spot price, so the investor stood to make over 9.3% even if PSX rose over $100.00.
Similarly, an investor could have shorted the $85.00 strike price put options and received $1.60 per contract. That worked out to a premium-to-strike yield of 1.88% or 22.6% annually.
Today, an investor can look at the June 30 expiration period for similar trades. For example, the $103 strike price calls trade for $0.75 per call contract. That strike price is 6.40% over today's price and provides an immediate yield of 0.77%. That represents an annualized return of 9.24% if repeated each month for a year.
A more conservative investor may want to sell short the $104 strike price for 55 cents, or a yield of 0.57%. That still works out to an annualized rate of 6.84%.
On the short-put side, traders can make more money. For example, the $91.00 strike price, which is also 6.0% away from the spot price (see above), trades for 95 cents. That represents a premium-to-strike yield of 1.04%, or 12.5% annually.
This means that a trader who secures $9,100 in cash and or margin with their brokerage firm can enter an order to “Sell to Open” 1 put contract at $91.00. Their account will immediately receive $95.00. So that shows that the immediate yield is 1.04% (i.e., $95/$9,100).
In fact, some investors may want to both hold the stock long and do both of these trades. That way they can get paid on both the OTM put and call side. As long as PSX stock does not move a great deal during the next 24 days, the investor will collect over 1.81% (.77% on the short call side and 1.04% on the short put side).
This shows that a patient value investor in PSX stock can make good money. This is because it is selling below its valuation averages, as well as from short option income plays.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
