Dividends make a big difference in investment returns, particularly when the overall stock market is not likely to be very strong, says E. Clifton Hoover Jr., lead manager of the $1.4 billion PIMCO Funds:NFJ Small Cap Value/A (PCVAX).
Hoover expects that the overall stock market will return only about 4% to 5%, annualized, over the next few years. As a result, he said, “it’s the 3% dividend that puts you on the way to above-average market returns.”
He is enthusiastic about the dividend tax cut signed into law recently by President Bush. “As the baby boomers move into their retirement years,” Hoover said, “they will need more yield” and will seek out the new tax advantages of dividend-paying stocks.
All of the 100 or so companies in the fund pay dividends. If a company eliminates its dividend, shares are sold immediately, he said. Over all, the dividends of the portfolio companies average 3%, compared with about 2% for companies in the benchmark Russell 2000 value index.
He starts by screening roughly 4,500 American companies with market capitalizations of $100 million to $1.5 billion at the time of purchase, eliminating companies that pay no dividends.
He sorts the remaining stocks into about 160 industries and discards companies in the top one-fifth of a ranking based on their trailing and p
The 500 or so remaining candidates are filtered through what Hoover calls a “price momentum” model based on the moving average of their stock prices over the previous 49 weeks. He eliminates companies whose stock prices lag behind the overall market.
Next, he screens for earnings revisions over the last three to four months, aiming to identify companies whose earnings may soon begin to rise.
Hoover also looks at asset quality. “During the bubble, a lot of companies paid too much for acquisitions,” he said, “so many have a significant portion of their assets in good will.”
Most important, he said, is knowing why a company’s shares sell cheaply. For example, the winter of 2001-02 was relatively warm, “so Wall Street marked down all natural-gas companies, giving us an entry point to buy shares,” he said.
Hoover first bought shares of Patina Oil & Gas (POG), based in Denver, in early 2001. Natural gas accounts for about two-thirds of its production revenue, and shares sell cheaply, Hoover said. “Gas prices are rising but the stock market hasn’t digested that yet,” he said.
In February, the fund began buying shares of the Cato Corp`A` (CTR), based in Charlotte, N.C. Cato operates more than 1,000 stores, mainly in the Southeast, that sell moderately priced women’s clothing. Shares are a bargain based on their P/E ratio of 11, based on projected 12-month earnings, Hoover said. “It’s a sleepy company that doesn’t intrigue Wall Street,” he said, “but it’s well run and continues to generate cash flow.” The company’s dividend is 3.3%.
Another holding, the Teekay Shipping (TK), based in the Bahamas, pays a 2% dividend. The company operates oil tankers, using a modern fleet that minimizes the potential for spills, Hoover said. The company is well run, he said, but shares still sell cheaply — based on the ratio of price to cash flow — because the business is cyclical. He said he expects share prices to increase in line with rising oil prices.