By Tom Dyson, publisher, The Palm Beach Letter

Monday, December 29, 2008

Last summer, I went to visit Iowa Telecom.

Iowa Telecom serves 417 communities in the countryside 90% have fewer than 2,000 people. It avoids towns. The largest town it operates in is Newton, Iowa. population 15,000.

It has no competition. and it never will. There is simply no scenario where it would be worthwhile for a competitor to build a network to serve towns with three farmhouses. This is Iowa Telecom’s moat. Plus, only 28% of Iowa Telecom customers are businesses, so the company doesn’t have much exposure to business downturns.

Iowa Telecom has all the qualities of a safe dividend stock. It cannot expand, it pays almost no taxes, and it cranks out the same cash-flow numbers every quarter. Management pays out almost all its cash flow in dividends. When I first went to visit the company, it was paying a 9% dividend.

But here’s the kicker. After I’d toured the premises, met management, and studied the company finances in the boardroom, I got into a casual conversation with the chief financial officer. He gave me the best indication that Iowa Telecom would make a good dividend investment.

He said to me, You know I just bought a farm. And I overpaid for it. Well, if you want to know what I think of our dividend, put it this way: I’m depending on the cash flow from our dividend to pay for my farm.

Over the last six months, Iowa Telecom’s stock price has fallen 23%. And it’s still paying the same 40-cent dividend payment. The yield is now 12%.

Now, even though the stock is down 23%, my readers have only lost 9% on the position. That’s because we’ve made 7% by collecting dividends and another 8% by selling call options against our position. That’s 15% income in seven months. during the worst bear market in 30 years.

When you sell call options against a stock, you’re running what the pros call a covered call strategy. You sell the potential future upside in the stock price to another investor in return for a large fee. They call this fee an option premium. By collecting this option premium, it’s easy to double or triple the income you receive from your stock positions. Your downside hasn’t changed, except now you have the option premiums to pad your returns.

If you believe your stock has huge upside potential, you wouldn’t want to sell the upside potential to another investor. But with Iowa Telecom, I couldn’t see any reason for its stock price to rise. It pays out all its profits and has no expansion plans. It’s like a bond, in other words. I was happy to sell the upside potential.

The current market is perfect for using a covered call strategy. Option premiums are extremely high thanks to the volatility (although they are falling), and America’s strongest blue-chip stocks are selling at generational lows, paying the highest dividend yields since the 1980s.

These companies are safe. But as long as we’re mired in recession, I don’t believe they have much short-term upside. So I’m happy to sell this upside away to eager option buyers for high premiums.

I call this strategy the double-digit bear market income secret.

If you’d like to learn more about covered calls, give your broker a call and ask him to explain the trade. It’s the only way to earn safe income in a bear market.