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What if you could combine the pleasure of eating chocolate
cake with the health benefits of eating vegetables? Or say I
knew a way to get in great shape... without moving a muscle.
Well, unfortunately I don't. You still have get healthy by
eating vegetables and running up hills. But I do know of
something that combines the best of two worlds for income
investors.
A financial innovation called
STRIDES is making high income securities out of
low-yielding growth stocks. As a result, you can earn a
generous income stream while still participating in the
appreciation potential of some of the world's greatest
growth stars, even if they don't pay dividends at all.
What are STRIDES?
STRIDES, or STock Return Income DEbt
Securities, are senior unsecured debt notes issued by
Merrill Lynch that are linked to an underlying stock. The
underlying company has nothing to do with the issuing of
STRIDES, but their performance does determine how investors
will profit. They've been issued for companies such as
Oracle (Nasdaq: ORCL), Apple (Nasdaq: AAPL), and Monsanto
(NYSE: MON).
The special asset class is exciting for income investors
because over their short, two-year lifespan, the securities
pay yields of up 12% annually in interest. And because the
STRIDES convert into shares of the underlying security at
maturity, they allow you to not only earn a generous yield
from low-paying companies -- but benefit from their growth
at the same time.
Capital Appreciation from Growth Stocks...With High
Yields
In addition to their hefty yields, STRIDES can offer
significant appreciation potential. Since they convert into
stock at a pre-determined ratio, their prices can soar if
the underlying shares rally.
For example, the Apple 12% STRIDES due 9/5/2009 (NYSE:
AVN) were issued at $25 each and make interest payments
of $0.75 each quarter. Right now the STRIDES yield 11.8%.
AVN is convertible to 0.18750778 Apple shares at maturity.
At Apple's current price of $135.40, the STRIDES are worth
$25.40 ($135.40 x 0.18750778). But if Apple were to rise to
$160, the conversion ratio would mean AVN would be worth $30
per note.
So not only do STRIDES enable investors earn a double-digit
yield, but they get to also enjoy some of the upside of the
underlying shares.
Downside Protection of Income Stocks
And while STRIDES can offer a high yield and take advantage
of rising share prices, they offer downside protection to
boot. If the underlying stock price falls, so will the
STRIDES -- but their high yields help cushion returns.
Monsanto 12% STRIDES due 3/26/2010 (NYSE: MYX)
illustrate just how much protection STRIDES can offer. This
security is yielding a powerful 13.3% right now.
Since being issued at $25 in March 2008, MYX has seen its
share price (excluding dividends) fall about -10%. However,
thanks to the high yield it offers, investors have been
saved from the tumult in the common shares. Over the same
time period, Monsanto common stock has fallen -36% and the
S&P 500 has fallen -35%.
In addition to the price holding up stronger than the
underlying shares, MYX has already paid $3.75 in
distributions. When you add those into your total return, it
means in one of the worst markets in recent memory,
investors in MYX are actually up +5%!
No Investment is Risk Free...
I don't want you to think that STRIDES are a risk-free
investment. In fact, if the underlying shares fall too far,
then investors will be saddled with shares at maturity that
could be worth much less than the $25 par value of the
STRIDES.
In addition, STRIDES are callable, so if the underlying
shares rise too much, they are at risk of being called away.
But with a guaranteed yield-to-call that is typically around
+20%, your returns aren't likely to suffer much.
With this in mind, STRIDES are one of the most compelling
new investments to come along in years. Income investors
should be on the lookout to add this powerful tool to their
investing arsenal.
Tom Hutchison
Carla Pasternak's Dividend Opportunities
P.S. -- My colleague Carla Pasternak recently
covered high-yielding STRIDES -- and a few other new income
securities -- in her July issue of High-Yield Investing.
To learn more,
visit this link.
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