Quick Take: With the market undergoing “a bear of all bears,” Cliff Hoover Jr., co-manager of PIMCO Small Cap Value Fund (PCVAX), touts his fund’s mantra of holding only dividend-paying companies as sound. As the bear market eats up much of the capital appreciation promised by companies not paying dividends, Hoover thinks firms with reliable dividends are the best source of long-term investment gains.
Hoover also thinks the discipline of paying regular dividends keeps companies from spending too much on plants and equipment, as Corporate America has in recent years.
Focusing on dividends has paid off for Hoover, since he says it has kept the fund in steadily growing companies and out of imploding sectors such as technology. This year through August, the fund was up 2.3%, while the average small-cap value fund lost 10.2%. Last year PIMCO Small Cap Value rose 18.6%, while its peers gained 14.1%.
The Full Interview:
S&P: What sets your portfolio apart from other small-cap value funds?
HOOVER: One fairly unique ingredient is that every holding must pay a dividend. Today, the fund’s yield is about 3%, but we hold stocks with various yields, including utilities and REITs, whose average yields are about 7%.
Another relatively unique factor is that we have a diversified portfolio — about 100 stocks in about 50 industries.
S&P: Why do you focus on dividend-paying companies?
HOOVER: Dividends instill discipline in corporate managements We feel it is very important for a management team to return some cash back to shareholders. Maybe then companies won’t buy a tenth factory as a result. Studies now show that many corporate reinvestments of cash in the last ten years were poor uses of capital.
You can’t simply trust managements to always reinvest money properly and then expect to see the results through stock appreciation. Maybe you will and maybe you won’t. We think the pendulum is swinging back to dividend-paying companies. Studies also show that dividend-paying stocks outperform non-dividend paying stocks.
S&P: Is it difficult to find enough dividend-paying stocks?
HOOVER: There is a scarcity of dividends now. Corporate America is probably so leveraged that many companies won’t be able to implement a dividend for some time.
S&P: What are your price/earning parameters for holdings?
HOOVER: We don’t like to own a stock with a higher valuation than our universe, the Russell 2000, which has a p/e of 22. Even in industries where p/es are typically higher, we wouldn’t own a stock.
We won’t just gravitate to the low p/e industry. If one industry has a p/e of 6 and another industry has a p/e of 12, we won’t just pick the 6 p/e industry. We’ll assess the two industries and look at the industry structures. Then, we may decide that the 12 p/e industry is cheaper historically than the 6 p/e industry.
S&P: Do you consider sector trends when picking stocks?
HOOVER: Our approach is primarily bottom-up, but we do consider some sector features. Some industries don’t pay dividends, so we avoid them. We don’t think you can compare price/earnings ratios across industries, so we try to identify value within industries. Our job is to find cheap stocks that don’t deserve to be cheap, because you can get caught by value traps.
S&P: Do some industries look attractive?
HOOVER: We think there are opportunities in the energy industry. Natural gas supplies are tight, so all we need is a normal winter, and you’ll see high gas prices.
I also think we’re in the early stages of a bull market in gold. There was a 20-year bear market in gold, so production has fallen below demand. The only thing keeping gold prices down is gold sales by European central banks. If you excluded these sales and looked at pure supply and demand, the true price of gold would probably be around $400. Today, it’s selling at $324. We own one gold stock — Goldcorp Inc. (GG), which is up about 90% this year. A Canadian company, it was the only one we could find with limited geopolitical risk.
S&P: What are the fund’s largest industries?
HOOVER: Financial services, the largest, is about 26% of the fund. Within finance, we have an 8% position in REITs, six little banks, two savings and loans, five insurance companies, and one little brokerage company — Southwest Securities (SWST.OB). We also have a 15% weighting in utilities, and a 9% weighting in materials and processing.
S&P: Have you made any stock purchases this year?
HOOVER: We’ve purchased Cooper Cos. (COO), which makes contact lenses; Fresh Del Monte Produce (FDP); and Lubrizol Corp. (LZ), a special chemical company. They are all from different industries. We didn’t focus on any one sector.
S&P: Why has the fund outperformed its peers in recent years?
HOOVER: It wasn’t a top-down bet, but we didn’t have any tech exposure in 2000 and 2001.
S&P: What are your largest holdings?
HOOVER: As of June 30, they were Fresh Del Monte Produce and Brown Shoe (BWS), each a 1.4% position.
S&P: What are your outlooks for the market and the economy?
HOOVER: This market could be the bear of all bears. That’s because we had the boom of all booms. It’s not the time to be aggressive. We’ll probably have a 5% annualized return for the market, so I think it will be great time for active stock pickers.
But the $64,000 question is how will the real economy recover? We think a double dip in the economy is fairly likely. The U.S. consumer is getting tired of holding up the economy by taking on more debt. I think the Federal Reserve will probably manufacture a slow recovery, but if there’s too much debt in the economy along with anemic demand, we could have stagflation. It will be a very tough decade.