Every other issue of The Validea Hot List newsletter examines in detail one of John Reese’s computerized Guru Strategies. This latest issue looks at the Peter Lynch-inspired strategy, which has averaged annual returns of 11.2% since its July 2003 inception vs. 6.4% for the S&P 500. Below is an excerpt from the newsletter, along with several recent top-scoring stock ideas from the Lynch-based investment strategy.
With Christmas just around the corner, John Buckingham says undervalued dividend stocks are on his Christmas list.
Looking for strong dividend stocks? Some top fund managers are finding them in an unlikely place: the tech sector.
In his first-quarter letter to shareholders, top fund manager Bill Nygren of Oakmark says that he’s keying on companies that are putting their cash to work.
“Corporations today have unusually strong balance sheets and are generating much more cash than they can profitably reinvest in their own businesses,” Nygren writes. “Unless managements just let the piles of cash keep growing, which is clearly suboptimal, there are only three ways to deploy it: higher dividends, share repurchases and acquisitions. And companies are doing all three.”
Nygren says that most investors don’t focus on those uses of cash. “They assume that EPS growth and dividend growth will mimic organic net income growth and that, when they diverge, it is unsustainable,” he says. “We believe that historically low dividend payout ratios make it likely that dividend growth will exceed EPS growth for years to come.” Last year, he says, the S&P payout ratio was 30%; from the 1960s to the 1980s, it was 50%. “If earnings grow at 5% per year, and if by the end of the decade the payout ratio has returned to 50%, annual dividends will have grown at a double-digit rate, more than double the rate of earnings growth,” Nygren says. He adds that he thinks EPS growth will exceed organic net income growth. “Most of the share repurchases and acquisitions that our companies made last year were funded from cash generated in the normal course of operations, not from a one-time levering up of their balance sheets,” he says.
In his latest column for MSN Money’s Top Stocks, Validea CEO John Reese highlights a handful of high-dividend stocks he thinks are worth a look right now.
“In the months leading up to the fiscal deal, high-dividend stocks have been taking some hits,” Reese writes. “While fiscal cliff and higher taxes on dividends may not be the only reason, no doubt these concerns were playing some role in dividend stocks’ sluggishness.”
But, he says, the declines “have shaken some of the excess bullish sentiment out of high dividend plays, which had gotten fairly pricey earlier this year as investors, starved for yield in the current low-interest-rate environment, flocked to them. What’s more, there’s some intriguing research showing that, historically, high-dividend stocks haven’t suffered when dividend taxes have been high or increasing dramatically.”
Reese discusses that research, and looks at five high-dividend plays that his Guru Strategies — each of which is based on the approach of a different investing great — are high on right now. Among them: Japanese telecom NTT Docomo.
T. Rowe Price’s Tom Huber, whose Dividend Growth fund is in the top 13% of funds in its category over the past five years, according to Morningstar, says that tax increases associated with the fiscal cliff aren’t reason to avoid dividend-paying stocks.
“There is a lot of discussion and worry [about the tax hikes] more than I think it deserves,” Huber tells Barrons.com. “Higher tax rates are not good. But I think [these stocks] have been shown to work over time.”
While consumer staples, utilities, financials, and telecom have traditionally been areas to find strong dividend plays, Huber says that’s changing, with consumer discretionary and tech firms now joining the dividend players. “Utilities and telecom stocks have higher yields, though the payout ratios are higher and dividend growth is slower,” he says. “But because technology stocks are new to the dividend-paying world, the payout ratios tend to be lower, which leaves lots of room to raise payments.”
Huber also talks about his dividend strategy. He says he generally wants his portfolio to have a market-level dividend yield, but he focuses on firms that he thinks can grow their dividend payouts faster than their broader sectors. He talks about some of his current favorite picks, including Automatic Data Processing and Pfizer.
The Wall Street Journal’s Matt Phillips has a simple message for investors: Do not forget about dividends.
“Dividends matter! Dividends matter! Dividends matter!” Phillips writes on the Journal’s “MarketBeat” blog. He references recent commentary from Standard & Poor’s Howard Silverblatt as proof. “We are near another all time high for total return, even as stocks remain 10.2% off their all time high,” Silverblatt said. “We need a 0.14% total return to set a new record, which includes today’s dividends adding .02%.”
Silverblatt says the indicated dividend rate is “up 13.0% from 12/30/2011, 2012 payment estimated to be an all time high. Given the timing of the increases, unless issues decrease their dividends (in which case don’t worry about dividends -> means everything is going down) 2013 already has a +3% payment increase built in.”